USD Rates: Fed tapers, watch payrolls

Fed starts policy normalization.
Eugene Leow05 Nov 2021
    Photo credit: Unsplash Photo

    The US Federal Reserve took another step towards policy normalisation by reducing the monthly pace of purchases by USD 15bn per month for November and December. At this pace, taper would conclude in June 2022.  Note that this commitment does not extend beyond two months as Fed Chair Powell sought to preserve policy flexibility in case inflation proves persistent or if the labour market conditions tighten rapidly. We felt that the Fed toed the line well and there was no shock to the market. The Fed has turned incrementally hawkish since June, with short-end rates incrementally pricing in the rate hike cycle. Fed funds futures are pricing in a rate hike in mid-2022 with the Fed funds rate heading into the 1.50-1.75% range in end-2024. We acknowledge that the Fed may have to load a couple of hikes into 2022 instead of waiting till early 2023 (current house view).

    Meanwhile, we think that upward pressures on the 2Y-5Y segment might resume. We were a tad cautious ahead of the FOMC meeting, noting that the market has priced in a lot of Fed hikes over the past 4-5 weeks. However, we think that the Fed is data dependent and seem to be in alignment with the market. Forward guidance is not as important when the economy has exited the crisis and judging from jobless claims and ADP employment numbers, Friday’s payroll (consensus: 450k) should prove strong. In which case, the market could factor in more hikes into the intermediate tenors. DM yields were also thrown into disarray when the Bank of England refrained from hiking even as the market had priced it in. This sparked a rally across all tenors of UST as market participants pared tightening bets. Having fallen, we think 2Y-5Y USD rates are at more interesting levels for those keen to pay. 

    Longer-term yields took a round trip, rising post FOMC meeting as the market pared stagflation fears but retraced amidst a dovish BOE. We view growth as still reasonably strong even if inflation is likely to stay elevated. Wednesday’s ISM services and ADP figures suggest that the recovery momentum is intact. We are sticking to our view that 10Y and 30Y at 1.50% and below 2.00% is simply too low and represent pay opportunities. In the next few weeks, upside may depend on progress on President Biden’s infrastructure and social spending packages (totalling a watered down USD 2.25tn). Beyond that, we think that implied real 5Y5Y yields are still too low and has scope to rise in the coming quarters as Fed normalisation progresses. 

    Eugene Leow

    Senior Rates Strategist - G3 & Asia
    [email protected]


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