After months of impassivity, the financial markets are beginning to take seriously the determination of the Federal Reserve (Fed), the central bank of the United States, to fight against inflation. Interest rates soared sharply on Friday March 25, with the yield on ten-year US government bonds jumping on Monday March 28 in the morning to 2.55%. This rate, which had fallen in July 2020 in the midst of the Covid-19 pandemic to a low of 0.5%, was still only 1.72% at the beginning of March.
America is coming out of several years of free money and investors are now demanding a three-year high compensation due to inflation, which will eat away at their capital. These rates are however derisory, much lower than annual inflation (7.9% in February). One explanation is the war in Ukraine, which delayed the rise in market rates: in times of panic, favoring security over yield, investors rushed into the greenback and American assets, even if they were less remunerative. They then thought that Fed Chairman Jerome Powell would be reluctant to turn on the monetary tap so as not to add uncertainties to the war. The opposite happened: the central bank estimates that the Russian invasion will perpetuate inflation, because of the shock on energy and agricultural products that it causes. To this must be added the partial shutdowns of the Chinese economy due to Covid-19.
A very political choice
These external shocks reinforce the bottlenecks that penalize the recovery of the economy and fuel inflation, fueled by years of ultra-accommodative fiscal and monetary policies and by labor shortages. As a result, operators believe that the Fed, which until December described inflation as ” provisional “, will tackle the rise in prices by raising its rates, at the rate of half a point per meeting, instead of the 0.25% initially envisaged.
At this rate, its key rates, which determine the cost of money in the short term, could rise from 0.25% today to 2.75% at the end of 2023. Long rates, which are used to finance companies, should follow this movement, especially since the Fed should stop buying US Treasury bonds, which have enabled it for years to keep long-term rates low.
Will the Fed make the decision to become “hawk”, ie restrictive, after having been “dove”, ie accommodating, for years?
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