The Bond Market Stirs The U.S. 10-year Treasury bond yield backed up toward 3.25% last week — levels not seen since 2011. Comments by Federal Reserve Chairman Jerome Powell point toward higher rates, perhaps higher than the market currently expects. Economic growth remains strong, labor conditions are growing tighter, and inflation expectations are becoming less clear. Markets have heretofore priced in a very shallow path for future rate increases, but that perception may now be changing given an unemployment rate near 50 year lows and market-implied long-run inflation forecasts are above 2% and moving higher. The net effect of changes in the outlook for short-term rates, inflation expectations, and the long-end of the yield curve is a slight steepening of the curve (chart, below).
Ultimately, we think the Federal Reserve’s rate setting will be closely tied to what happens with inflation, but what happens further out on the curve has more to do with market expectations. If investors around the world become less certain about inflation and the outlook for global growth, for example, they could require a higher return to hold longer-dated bonds. Left to the market’s own devices, the prices of longer term bonds would tend to fall as yield rose to reflect greater uncertainty and investor perceptions of risk. China and Trade Adding to a perception of risk is uncertainty over trade. Although we have had some positive developments in North American trade negotiations, there is still concern that negotiations with China are headed in a different direction. The chilling of negotiations between the United States and China suggest an additional 25% tariff on all Chinese imports is more likely in the early part of next year. We are carefully watching how this plays out with regard to business confidence, inflation expectations in the United States, and the policy responses from the Chinese government. To date, we have seen some reciprocal tariffs and currency devaluation, but additional signs of pressure on their economy could elicit a more forceful fiscal policy response. For now, we remain with our key tactical calls which are summarized in our latest Q4 Tactical Asset Allocation quarterly report. Kevin Caron, CFA, Senior Portfolio Manager Chad Morganlander, Senior Portfolio Manager Matthew Battipaglia, Portfolio Manager Suzanne Ashley, Analyst 973-549-4168
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