The Fed maintained its dovish stance on Wednesday and offered very little in the way of resistance to the ongoing rise in US Treasury yields.
The median dot plot chart showed interest rates unchanged through 2023, though we did see a change here with seven of the 18 FOMC members now indicating a hike before the end of 2023, up from five members at the last meeting. At the press conference that followed the meeting the rhetoric from the Fed chair, Jerome Powell, basically echoed the dovish tone from previous commentary which had done little to prevent the Treasury yield curve steepening.
However, we have seen a raft of upward revisions to US growth forecasts from investment bank analysts recently that have fuelled the steepening of the Treasury curve, which for us made three of Powell’s comments particularly pertinent.
First and perhaps the most obvious was that the Fed is focused on actual data and not forecasts, which is understandable given the unprecedented conditions the US economy is working through. The Fed’s growth forecast has also been revised higher, but it remains consistently lower than the pace expected by the Street, partly because the Fed sees the recovery as being ‘uneven’.
Second, when questioned on whether the Fed was likely to change the composition of its purchases from $80bn of Treasuries and $40bn of mortgage-backed securities per month, Powell said he was happy with the current mix.
Finally, and to us perhaps quite telling, was the Fed’s view that inflation spikes coming as a consequence of the sharply higher growth the US economy is set to experience would also be transitory. On this last point, while we know transitory inflation from base effects or currency moves doesn’t tend to cause a problem for the economy, we are not totally convinced that an inflation spike from a period of rapid growth should be classified in the same benign way.
All told we see this as a very dovish Fed and while in the long run it might be correct, in the short term it feels like the market just doesn’t believe this story and sees the need for rate hikes sooner, which will leave the Treasury curve vulnerable to further curve steepening.