Central bank

Fed tweaks forecasts, we tweak ours

30 June 2021 • 3 mins read
  • This month’s hawkish Federal Reserve tweaks - discussing when to taper quantitative easing and forecasting earlier rate hikes - are the start of its gradual exit from its very dovish stance.
  • The Fed’s moves have hit reflation trades, injecting volatility into risk assets, flattening the US yield curve, lowering inflation expectations, weakening gold prices and lifting the USD.
  • We think the Fed’s leadership, however, is more dovish than its new forecasts imply and will only taper quantitative easing in 2022 and may wait until 2024 before hiking interest rates.
  • But the Fed’s tweaks are affecting sentiment. We thus tweak our own US Treasury forecasts while still expecting 10Y yields to reach 1.90%.

The Federal Reserve’s hawkish tweaks this month - discussing when to taper quantitative easing and updating its forecasts to show its fed funds rate is likely to be increased from 2023 - are the start of its gradual exit from its very dovish stance. The Fed’s moves have thus hit reflation trades by raising fears that future growth will be undercut.

Source: Bank of Singapore, Bloomberg

We think the Fed’s leadership, however, is more dovish than the central bank’s new forecasts imply. We expect tapering will only begin in 2022 and the fed funds rate may remain at 0.00-0.25% until as late as 2024. But the Fed’s tweaks are affecting sentiment now. The first chart shows 2Y Treasury yields have reached 0.25% for the first time since the pandemic began in early 2020 as the bond market anticipates earlier rate hikes. 

Source: Bank of Singapore, Bloomberg

Conversely, long-term 10Y and 30Y yields have fallen as investors mark down future growth. This has flattened the yield curve. The second chart shows the spread between 2Y and 10Y yields now stands at 125bps. In May it was over 150bps. 

Source: Bank of Singapore,

We thus tweak our own Treasury rate forecasts and now expect 2Y yields will rise further to 0.50% over the next 12 months as speculation about early Fed rate hikes continues. We also think 30Y yields will reach 2.60% but that is lower than our earlier estimate of 2.90% as we see the curve being less steep now. Our forecast for 10Y yields, however, is still 1.90%. The strong US recovery, buoyant risk assets, Fed tapering and inflation from America’s reopening are set to push the benchmark yield closer to 2% in 12 months’ time.

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Mansoor Mohi-uddin
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