Exposure rates of the Dorval Asset Management Range – 18th June 2021

The Fed has marked the start of a fresh phase in its monetary policy, indicating that it is starting to talk about tapering its asset purchases. 

Powell’s optimistic stance on the outlook for the labor market as well as the increase in the number of FOMC members who believe that interest rates will be raised in 2023 have been interpreted by investors as a sign of future monetary policy tightening.

The Fed’s position over the past several months can be summed up as follows: (1) the surge in inflation in 2021 is a passing phenomenon and can be explained by the sudden reopening of entire portions of the economy, (2) it is crucial to re-anchor inflation projections at a pace in line with its target via “real” full employment and (3) references to a gradual tapering of its asset purchases are a way of keeping a lid on excessive inflationary concerns.

 

The new phase that is kicking off acts as a natural stress test for the credibility of the Fed’s position. Can the Federal Reserve keep inflationary fears under control without disrupting the reflation trend? In the very short term, the market reaction tends more towards an interruption in reflation: the yield curve is flattening in the US, inflation projections are falling again, the dollar is strengthening, banking stocks are correcting, and defensives are outperforming. Beyond this short-term price realignment, we can legitimately wonder if the Fed has not recklessly jeopardized its reflationary goals. Economic data over the weeks ahead – particularly US job stats – will settle this question.

 

Drop in inflation projections and rise in real rates

10-year nominal rates / 10-year inflation projections / 10-year real rates

 

 

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