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Edward Bell - Senior Director, Market Economics
Published Date: 29 April 2021
The Federal Reserve maintained policy unchanged at the April FOMC, holding the Fed Funds rate at 0.25% on the upper bound and continuing monthly asset purchases of USD 120bn/month. The Fed did upgrade its outlook for the US economy, noting that “indicators of economic activity and employment have strengthened” and that “sectors most adversely affected by the pandemic remain weak but have shown improvement.” In its FOMC statement, the Fed noted that inflation is rising but continues to describe the factors pushing inflation higher as “transitory.”
Markets generally took the April FOMC as dovish, even with the acknowledgement of improvements in the economy. US Treasuries rallied led by the belly of the curve: 5yr UST yields fell 3bps at the close to settle at 0.8508% while 10yr yields fell 1bp over the course of the day to 1.6094%, although that did disguise a 4bps intraday drop in response to the FOMC. The dollar was broadly offered in response to the FOMC with EURUSD and GBPUSD recording notable overnight gains.
In the press conference following the statement, chair Jerome Powell noted that the economy was still “a long way from our goals” and pushed back against any incipient tapering of accommodative policy. Powell also noted that the Fed would signal “well in advance” of any actual tapering of asset purchases. We would expect that when the Fed does begin to tighten it would follow a process of signalling to the market its intentions, strengthening its forward guidance/economic projections, lowering the monthly purchases and then finally concluding with interest rate hikes. While the US economy is likely to power ahead this year—Q1 GDP estimates will be released at the end of this week with a consensus for 5.4% q/q growth—we still expect to see the Fed to keep policy accommodative well into the end of 2022, even at the risk of letting inflation trend higher for a prolonged period.
With the Fed affirming its easy monetary policy amid an improving economy catalyzed by household incomes in good shape and a successful Covid-19 vaccine rollout, we would expect to see the stand-off between the Fed and markets persist across the course of Q2. Treasuries have moved higher since the start of April, abetted by risk-off moves related to the collapse of a substantial investment fund in the US but also seemingly an acceptance that the Fed means what it says when it says it isn’t planning to shift policy any time soon. As base effects will amplify the ongoing improvement in data in coming months, we would expect to see heightened volatility in rates markets in the weeks ahead. Our general view for this year is to see yields rising in line with the improving economy. However, the move higher in Q1 appeared to us too early and we think that a pull-back below current levels of around 1.60% by the end of Q2 looks fair.
Lower UST yields may extend a bit more room to emerging market bonds to see yields compress further after an uptick in Q2 so far. Hard currency emerging market bonds are up 1.2% so far in Q2 while local currency bonds have added more than 2%. However, as we outlined in our note earlier this month (read more here), domestic issues related to vaccine rollouts as well as volatility in UST markets may make further gains more challenging.
Emerging markets at risk of higher US yields
US yields race ahead
Inflation and the Fed
Gold prices stumble to start 2021