(Bloomberg) - The bond market is misunderstanding the Federal Reserve by building interest-rate increases into the short end of the yield curve starting as early as mid-2022 amid elevated inflation, according to Priya Misra at TD Securities (USA).
“The market is pricing in the first rate hike literally right after when tapering ends,” the firm’s global head of rates strategy said Tuesday in an interview on Bloomberg TV’s Surveillance. “Our view is that there are huge Covid impacts on inflation that are going to start to decelerate. Growth is going to slow, inflation will peak.”
TD doesn’t expect the Fed to raise rates until late 2023. The call runs counter to recent trading in the U.S. Treasury market, where the spread between 2- and 10-year yields narrowed to 97 basis points last week, the tightest since August, with traders pulling forward bets on Fed rate increases.
“It is not obvious to us that the Fed has to turn around and start hiking aggressively,” Misra said. “We actually have the first rate hike much later than when the market is pricing in, a steeper curve, the front end staying a lot more anchored.”
Providing evidence that investors are torn over the inflation debate, that yield spread has re-steepened this week, reaching 110 basis points on Tuesday.
Misra reasons that the 6.2% annual inflation rate reported for October, the highest since 1990, will drop as demand for jobs picks up, stunting attempts to raise wages.
“There’s a lot of hidden slack” in the labor market, she said. “We also think the service economy will pick up and create demand for those jobs.”
Besides, the central bank already “has taken a pretty big step” in combating inflation by starting to taper its bond purchases, Misra said. “They are already responding to the risk of high inflation.”
To be sure, St. Louis Fed President James Bullard, also on Bloomberg TV, said the central bank may have to speed up its reduction of monetary stimulus.
“It is ultimately a view on the economy and the outlook on the economy as we recover into this post-Covid world,” Misra said.
By John McCorry
