January’s consumer price index (CPI) was strong again with prices rising by 0.6% last month. Broad-based gains in food, energy, goods, services and rents pushed headline inflation up to 7.5% and core inflation to 6.0%. Inflation is now at a 40-year high, well above the Federal Reserve’s 2% goal.
Source: Bank of Singapore.
Inflation is set to peak in the spring as this year’s price rises ease compared to last year’s rapid gains. But the current strength of inflation is likely to make the Fed accelerate upcoming interest rate hikes. We expect the fed funds rate will now be raised from 0.00-0.25% by 25bps in March, May, June, September and December, making five rate hikes in total in 2022. The Fed may even tighten faster still. But we think a 50bps initial hike in March may be unlikely unless Chairman Powell explicitly signals such a move beforehand.
Source: Bank of Singapore, Bloomberg.
January’s CPI data caused US Treasury yields to jump. 2Y yields had their largest one-day gain since 2009, rising by over 20bps to 1.58%, while 10Y yields reached 2.03%. The risk of five (or more) Fed rate hikes this year is likely to increase yields further.
Source: Bank of Singapore, Bloomberg.
We thus revise our Treasury yields forecasts up. Our 12-month estimate for 10Y rates is 2.35% now. Faster Fed hikes are set to keep markets volatile near-term. But our new forecasts still imply yields will stay at low levels this year. Only a move up in 10Y yields to 2.80-3.00% would threaten its four-decade long downtrend that has benefited risk assets as the first chart shows. Nor do we see the curve - likely to flatten more as the Fed hikes as the second chart shows - inverting this year. That would signal recession which we do not expect.
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