The unsettling feeling about the prospect of rising inflation being linked to higher interest rates has become more noticeable during the past few months. However, there is an apparent logic behind all these concerns.
“Robust growth accompanied by higher inflation is traditionally a recipe for higher interest rates. The rise in the 10-year Treasury bond yield from 0.50% to a post-pandemic high of 1.75% reflects the improving outlook for growth and inflation”.
We have taken the words of our investment partners at Russell Investments explaining the reasons behind the thoughts of more gradual long-term rate increases to come during the upcoming months:
1 – The U.S. Federal Reserve (the Fed) has been clear it will look through a temporary spike in inflation due to base-effect comparisons to last year or due to any supply bottlenecks as the economy reopens. Russell Investments believe the Fed will not raise its target rate until late 2023 or early 2024.
2 – Market expectations for future inflation have been rising but have now reached consistent levels with the Fed’s inflation objectives over the long run. Interestingly, inflation expectation is now higher for the medium-term outlook compared to the longer term.
3 – While the economy is accelerating, the quarter-to-quarter growth rate will most likely decelerate over the second half of 2021, and the difference between actual and potential growth is not expected to close until sometime in 2022.
4 – The search for yield is a global phenomenon. Rising foreign demand would boost the value of U.S. Treasuries and lower their yield.
5 – The extra compensation that investors demand for owning a longer-term bond relative to rolling over of short-term bonds has normalised higher as well in recent months.
The positive is to expect future interest-rate increases to moderate. While this news could be considered unpleasant from a return perspective, the rise in interest rates improves the outlook for fixed income.
If you would like to read the full article, click on the link below. And, if you have an appetite to discuss this subject in more depth just get in touch with us, at Temple Row we are always eager to talk!
*Source Russell Investments UK. Article published on https://russellinvestments.com/uk/blog/rate-increases-slowing and written by Shailesh Kshatriya, Paul Eitelman on 14th May 2021.