Kristina Hooper, Chief Global Market Strategist at Invesco, expects discussions about tapering to begin at the US Fed’s meeting this week, and that tapering will likely be announced at Jackson Hole later, in the fall; she gives insights on two key questions
What drove the yield drop in the 10-year Treasury last week?
Rationalization of CPI print. The base effect is a legitimate reason for a higher CPI print for May. Then there were the components of CPI that showed the highest price increases.
Relief that the CPI print wasn’t worse. Markets were bracing for much worse, as whispers suggested the CPI increase would be higher, so a CPI rise of 5% was actually a relief. In other words, we dodged a bigger bullet, so we should be happy about the print.
Pandemic resurgence fears. The bond market was reacting to concern that some countries are having difficulty controlling Covid-19, especially with the more concerning Delta variant spreading rapidly, and that this might dampen economic growth. The Delta variant comprises 90% of new cases in the UK and is likely to become the dominant strain in the United States.
Markets finally believe the Federal Reserve. Markets have started to believe that the Fed’s new inflation targeting policy means it will remain “behind the curve” and tolerate higher inflation, especially since it is predisposed to the view that inflation as transitory.
Foreign demand for Treasuries. Investors outside the US are still attracted to Treasuries, especially given the very low rates in the eurozone. One catalyst last week was the weaker dollar, which spurred an increase in foreign buying of US government bonds.
Will this market behavior continue?
Yields moved up substantially earlier in the year in anticipation of rising inflation, so consolidation was likely. But that could all change this week if the Fed is not sufficiently dovish.
The Fed began a two-day policy meeting on June 15, and it could easily move longer yields higher. A revised dot plot could be one way to do that if it shows the anticipation of earlier or more aggressive rate hikes. And Fed Chair Jay Powell could easily push rates up if he shares that the Fed has started discussing tapering or suggests tapering could start in the next several months.
I expect discussions about tapering to begin at this meeting, and that tapering will likely be announced at Jackson Hole in later summer, planned to begin in the fall. But markets may not be ready to hear that yet.
I do expect yields to go up in the back half of this year and finish well higher than where they are today.
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