What’s new

Since the start of 2021, U.S. 10-year Treasury yields have climbed 0.75ppt to 1.63%. Investors appear to have priced in higher interest rates and inflation on the back of strong economic-growth expectations. Still, while yields have surged, they remain well below the Fed’s long-run rate of 2.5%. This suggests room for higher adjustments. If the 10-year yields approach 2%, we may expect some market volatility. The previous time the 30-year yield crosses 2% in February, the S&P500 retraces 4.2%.

Five takeaways

1. Dot plot suggests no rate hikes through ​2023, though more Fed officials tilt towards hawkishness. The Fed’s median dot plot – dot plots signal the Fed’s outlook for interest rates – suggests rates will remain on hold through 2023. Meanwhile, the Fed will continue to purchase assets of at least US$120bn a month. What has changed? Seven Fed officials now see a rate hike in 2023, up from five in December 2020. Four Fed officials now see a rate hike in 2022, up from just one in the December 2020 meeting.
2. Economic-growth forecasts raised. Median real GDP growth is projected to be 6.5% in 2021, up from December’s 4.2% expectation. This reflects a stronger-than-expected economic recovery from recent fiscal stimulus and ongoing vaccination.
3. Unemployment projections cut. Median unemployment rate is projected to be 4.5%, down from 5.0% in December. However, the Fed is observing different measures of unemployment, as headline numbers do not capture all the people out of the U.S. labour force. We believe it may be looking at the U-6 unemployment figure, which is right now 11.1%. U-6 includes everyone not accounted for in U-3, which is the most commonly reported rate of unemployment in the U.S. U-6 includes discouraged, underemployed and unemployed workers in the country. The high level of U-6 suggests that more time will be needed to revert to maximum unemployment, as discouraged workers slowly wade back to the labour force on the back of an improving economy.
4. Price increases this year may not meet Fed’s inflation goal. Prices are expected to jump this year following President Biden’s stimulus packages. Reflecting this, core personal consumption expenditure (PCE) inflation has been raised to 2.0-2.3% for 2021, above the Fed’s 2% inflation threshold. But as this may be partially attributed to a low base last year, Powell signalled that the “transient” increase in prices will not meet the standard for the Fed’s inflation goal.
5. Accommodative tone maintained. The Fed continues to see economic progress on the back of better economic indicators, including employment. Sectors most severely affected by the pandemic, however, remain weak. The Fed also believes inflation remains muted and “continues to run below 2%”. It further believes overall financial conditions remain accommodative. The tone of its statement suggests it is not concerned with bond-yield increases thus far.

Progress will be outcome-based, depending on how the labour market and inflation play out, before the Fed decides on further actions. Therefore, we may not see any change in stance in the near term, considering that unemployment remained high at 6.2% in February.

Powell also mentioned that advance notice on tapering will be given as much as possible. We believe a key indicator to monitor is any slowdown in its asset purchases. The Fed’s latest balance sheet continues to show an increase in assets.