Market Outlook Sees Treasury Yields Continuing To Trend Higher

The prospect of more interest-rate increases in the absence of rising inflation, based on the Federal Reserve’s latest forecast, strikes some as unnecessarily risky for the economy. But for good or ill, the central bank remains on track to lift rates further and the Treasury market (still) expects no less after the 25-basis-point increase from earlier in the week that pushed the Fed funds target rate to a 2.0%-2.25% range, the highest in more than a decade.

Using the Fed’s revised forecasts as a guide (published on Wed., Sep. 26), the outlook for US inflation remains tame at roughly 2.0%, which matches the bank’s target. The personal consumption expenditures (PCE) price index excluding the volatile food and energy components is projected to increase 2.0% this year, unchanged from the June estimate. So-called core inflation will tick up to 2.1% in 2019, the Fed predicts, but that’s also identical to previous outlook.

Is an upside inflation surprise likely for the near term? “We don’t see that,” Fed Chairman Powell said in a press conference on Wednesday. “It’s not in our forecasts.”

What, then, is convincing the central bank to keep rates on an upward trajectory? Solid economic growth that’s expected to persist. In fact, a plan to gradually raise interest rates “is helping to sustain this strong economy,” he said in a speech yesterday. He added that “there’s no reason to think that the probability of a recession in the next year or two is at all elevated.”

Never mind that trying to estimate recession risk two years out is virtually impossible. Regardless, the main takeaway from Powell’s latest comments: the Fed is confident that inflation will remain contained at or near its 2.0% target while economic growth will remain healthy.

Recent economic estimates certainly offer no reason to doubt the rosy outlook, as several examples from this week’s macro updates suggest:

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Disclosure: None.

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Hallsteinn Arnarson 2 years ago Contributor's comment

Good analysis. One pointer. I think the chart where you show both the 2y and the 10y yields should have the same scale, whether shown on one or two axes.

Bruce M. Knoth 2 years ago Member's comment

Good suggestion.