The Fed’s Mixed Messaging on the Yield Curve

Fed Chair Jay Powell is giving conflicting guidance to bond investors.

March 22, 2021


Last week’s FOMC meeting showed that the Federal Reserve (Fed) intends to maintain rates at zero even when the economy overshoots traditional measures of full employment and price stability. But Fed Chair Jay Powell stopped short of pushing back on the bear steepening of the Treasury curve.

Powell is giving conflicting guidance to bond investors. Dovish forward guidance is bullish for the short end while the Fed’s efforts to lift inflation expectations have been bearish for the long end. The belly of the curve is caught in the middle.

The question investors face is whether the selloff has more room to run. Our analysis suggests it has largely run its course. The market is now pricing in a neutral rate of 2.35 percent, nearly in line with the Fed’s optimistic long run dots. The chart below shows that the bond market has had difficulty sustaining rates at or near the Fed’s neutral rate projection, and we see no reason to expect a different result this time. Nor do we expect the Fed to revise up its neutral rate estimate. 

The Fed's Optimistic Neutral Rate Projection Is Almost Fully Priced In

The Fed's Optimistic Neutral Rate Projection Is Almost Fully Priced In

Source: Guggenheim Investments, Bloomberg. Data as of 03.19.2021. FOMC neutral rate projection is the median "Longer Run" dot from the Summary of Economic Projections. Market neutral rate projection is the 5-year forward 5-year Overnight Index Swap rate. Fed Funds Rate is depicted using the interest rate on excess reserves.

While the Fed has succeeded in lifting growth and inflation expectations, it now has a different problem: the market is pricing in premature rate hikes, as the chart below shows. The upshot for bond investors is that the steeper yield curve now offers an attractive carry and rolldown profile. If the Fed is as patient as we expect it to be, total returns for core fixed income investors have the opportunity to be much better going forward than they have been in the recent past.

The Bond-Market Now Believes the FOMC's Long-Term Rate Forecast, But Not its Short-Term Forecast

Forward Rates at Year-End
The Bond-Market Now Believes the FOMC's Long-Term Rate Forecast, But Not its Short-Term Forecast

Source: Guggenheim Investments, Bloomberg, Federal Reserve Board. Data as of 03.19.2021. Note: FOMC rate projections are available for 2021-2023. The FOMC defines its "Longer Run" forecast as being 5-6 years into the future.

From the Office of the Global Chief Investment Officer, Scott Minerd
By the Guggenheim Investments Macroeconomic and Investment Research Group

 
Important Notices and Disclosures

Investing involves risk, including the possible loss of principle. Investments in fixed-income instruments are subject to the possibility that interest rates could rise, causing their values to decline. High yield and unrated debt securities are at a greater risk of default than investment grade bonds and may be less liquid, which may increase volatility.

This material is distributed or presented for informational or educational purposes only and should not be considered a recommendation of any particular security, strategy or investment product, or as investing advice of any kind. This material is not provided in a fiduciary capacity, may not be relied upon for or in connection with the making of investment decisions, and does not constitute a solicitation of an offer to buy or sell securities. The content contained herein is not intended to be and should not be construed as legal or tax advice and/or a legal opinion. Always consult a financial, tax and/or legal professional regarding your specific situation.

This material contains opinions of the author or speaker, but not necessarily those of Guggenheim Partners or its subsidiaries. The opinions contained herein are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. No part of this material may be reproduced or referred to in any form, without express written permission of Guggenheim Partners, LLC. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information. Past performance is not indicative of future results.

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