NEW YORK - Investors are betting that newly renominated Federal Reserve Chairman Jerome Powell will need to step up the pace at which the central bank is normalizing monetary policy to deal with surging consumer prices.
Powell has insisted for months that the current bout of inflation is likely to be transitory, and said that the central bank will be patient when it comes to raising its benchmark rate from near zeroo. The Fed kicked off its $120 billion per month bond buying program in November, with a plan to end purchases in mid- 2022.
Some investors believe that the Fed will need to taper faster and raise rates sooner than expected to tame rising consumer prices, which grew at the fastest pace in more than three decades in October. There has been a debate among some Fed officials about whether to withdraw support for the economy faster to help tame inflation.
One barometer of investors' monetary policy expectations, futures on the federal funds rate, had priced in a 100% chance that the central bank will raise rates by July, from 92% last week. Rates market responds to Powell staying as the Fed Chair, https: graphics.reuters. On Monday, news of Powell's nomination sent yields on shorter-dated Treasuries, which are more sensitive to rate views to their highest level since early 2020. Powell is seen as more hawkish than Fed Governor Lael Brainard, who was also vying for the top job.
Mike Sewell, a portfolio manager at T. Rowe Price, said investors are challenging the Fed to some extent and are worried about the Fed falling behind the curve on inflation.
Sewell is buying shorter-dated Treasuries and the U.S. dollar, betting that the Fed will need to raise rates three times next year to tame inflation. Half of policymakers are planning to increase rates next year, according to the central bank's dot-plot released in September.
Analysts at Jefferies wrote Monday that the Treasury yields move inversely to prices and the prospects for a June 2022 rate hike have increased as a result of Powell's renomination, but the bank believes that a June rate increase is unlikely.
Gary Cloud, a portfolio manager of Hennessy Equity and Income Fund, has also drawn bets on shorter-dated Treasuries.
He said that investors haven't seen before because they have a lot of uncertainty as to whether the Fed will act in time to prevent inflation from spiralling higher.
The volatility in the Treasury markets has been caused by the divergent views on how aggressively the Fed will move. The ICE Bank of America MOVE Index, which shows expectations of volatility in the bond market, is near its highest level since April 2020.
On Monday, inflation expectations fell to their lowest in about two weeks, with 5 and 10 year breakeven inflation rates dipping to their lowest in about two weeks.
Some of the central bank's own policymakers have called for the Fed to normalize monetary policy more aggressively, which has reinforcing many investors views.
Vice Chair Richard Clarida said earlier this month that a discussion on increasing the pace at which we are reducing our balance sheet would be something to look at for the Fed's next meeting, while Fed Governor Christopher Waller called for the Fed to double up on its bond purchases by April 2022 to make way for a possible interest-rate hike in the second quarter.
Powell said that inflation will likely abate as supply chain bottlenecks that have contributed to higher prices will be loosened. There have been some indications that the worst of the disruptions are clearing up, with cargo shipping costs down by a third over the last month and prices for commodities such as iron ore and lumber tumbling.
Others insist that inflation is headed higher. Adam Abbas, a portfolio manager and co-head of fixed income at Harris Associates, is buying bonds from companies that may be able to better deflect the effects of higher inflation by raising prices.
As inflation proves stickier than expected, Donald Ellenberger, a portfolio manager at Federated Hermes, believes that bond market volatility will persist as a result of the bond market volatility. He plans to focus on shorter-duration Treasuries until the 10 year note rises to 2.5% or higher, a level he sees as appropriate given inflation.
He said that the Treasury market was very quiet for many years and rates didn't move very much. The market doesn't know what to do when faced with the fact that inflation is longer than expected.