Yields continue to rise.
The 10-year Treasury yield remained close to 14-month highs on Friday, above 1.7%, while the 30-year yield rose to 2.5%.
The bond market was on the alert after the Federal Reserve decided not to extend a rule that loosened banks’ supplemental leverage ratio, which could lead them to divest part of their Treasury bonds and further increase yields.
But PGIM Fixed Income chief economist Nathan Sheets says the Federal Reserve sees higher rates as a good development for now.
“The Fed sees rising interest rates occurring at the long end of the curve as a reflection of expectations for higher inflation, which is what the Fed has been trying to deliver for several years now, along with expectations of a strong recovery. ” Sheets told CNBC’s “Trading Nation” on Thursday. “I think that [Fed Chair Jay Powell is] very encouraged by it … as long as the increase is compatible with the improvement in economic prospects. “
Sheets, a former undersecretary of the Treasury for international affairs, said a 2% yield on the 10-year Treasury is a “reasonable assumption” that markets are pricing in the short term, but he sees no evidence that the increase in yields is decreasing.
This could become a problem for the bond market and the Fed beyond this year, he said.
“We will have a powerful recovery in the second half of this year, with many tax effects [stimulus] and goes back to normal with the vaccination campaign, but how much demand will be left over in relation to supply, aggregate supply, say, mid-next year? And I think there are some serious issues as you go beyond the short term, “he said.
Treasury yields are often seen as a barometer of inflation expectations – because when investors expect higher inflation, bonds become less attractive and are sold, while yields, which have an inverse relationship to bond prices, increase.
“As we reopen, we are likely to see some price pressures, people are going to demand goods and services and their supply may be a little delayed and it can create bottlenecks and shortages in some sectors, but then the key issue that I think the markets are debating is what it looks like after we move into 2022. Does higher inflation persist? … Or does it come out of the boil? Is it transitory? “said Leaves.
The Fed said on Wednesday that it expects core inflation to rise 2.2% this year, but to drop to 2% in 2022. Powell said the Fed will tolerate a “transient increase in inflation above 2%” without changing its monetary policy.
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