Ed Smith, asset allocation strategist at Rathbones, says fixed income investors have no need to panic over inflation. “We are not too concerned about the prospect of Fed tightening,” he says.
“While the interest rate swap market is only pricing in one to two more hikes after December’s, our base case is only for two to three.
This is for three reasons. First, our macro model of US inflation suggests the core rate will remain between 2.1% and 2.4% at the midway point in 2017 and most Fed policymakers have expressed a predilection for above target inflation.
“Second, the FOMC will become even more dovish next year as all hawkish members are replaced by more dovish regional chairs in the annual rotation of voting seats. Even if Trump replaces Janet Yellen and fills the two vacant chair with hawks, the doves will outnumber the hawks six to three, with four other members on the fence.
“Third, mortgage rates, interbank rates and longer-term bond yields have all risen sharply in the past few months, which tightens financial conditions without the Fed needing to move,” Smith adds.
“This is likely to stay their hand, especially if the dollar continues to rise, too.
“We are somewhat surprised about just how consensual continued curve steeping seems to be at the moment. We are not so convinced that long bond yields are such a one-way bet in 2017.”
