Sector Update

October 18, 2021

For most of last week, yields moved in a bear-flattening fashion. That is, shorter-term yields moved higher while longer maturity yields fell. From a high level, it makes sense for this to have occurred. Coming into last week, inflationary pressures were already on the mind of many; notably, Federal Reserve officials who were plenty vocal. The Federal Reserve can’t afford to lose control of the inflation narrative and they were out in full force last week. Below is a sample of comments from last week compiled by our Economics team.

Richard Clarida – “I continue to believe that the underlying rate of inflation in the U.S. economy is hovering close to our 2% longer-run objective” and that “once these relative price adjustments are complete and bottlenecks have unclogged,” the unusually strong inflation pressures will “prove to be largely transitory.” However, “the risks to inflation are to the upside.”

Raphael Bostic – “It is becoming increasingly clear that the feature of this episode that has animated price pressures – mainly the intense and widespread supply-chain disruptions – will not be brief. …By this definition, then, the forces are not transitory.”

James Bullard — supports a quicker tapering process than the consensus “because I want to be in a position to react to possible upside risks to inflation.” “There’s no reason for us to commit one way or another at this point,” Bullard went on, adding, “I just want to be in a position in case we have to move sooner that we’re able to do so next year in the spring or summer if we have to do so.”

Thomas Barkin — said that current inflation pressures “look more broad-based,” and “Because the risks are elevated, it seems like a sensible time to have the conversation about tapering.” However, there is less clarity on the rate path. “We still have a lot to learn about whether recent inflation levels will be sustained and how much room we have…in the labor market until we get to maximum employment,” Barkin said, addressing the forward guidance for rate hikes. “I do think…there is going to be a return to the labor force, and that is part of why…I am willing to be a little bit more patient,” he noted.

The struggle isn’t new, markets have been coping with transitory versus more sustained inflation pressures for some time now. A Bloomberg article, Team Persistent Tops Team Transitory in Latest Inflation Debate, summed it up well as the title says it all. It will be interesting to see if Federal Reserve speakers this week attempt to calm markets about tapering and future monetary policy plans.

From a practical perspective, what might this indicate for portfolio managers? If (and this isn’t a small if), a longer-term flattening trend emerges – a barbell approach to purchases, rather than a typical ladder, could be beneficial if the Fed raises short-term rates sooner than later which in turn could moot any increases in longer term yields as inflationary pressures subside and growth prospects potentially dim.

Today – Curve marginally steeper, stocks higher

Yields on 2-, 3-, and 5-year maturities at highs for 2021

Sector Commentary (click on links for more in-depth look)

What We’re Reading

Market Today | Daily

Weekly Recap | Weekly, Friday

Brokered Deposit Rate Indications | Weekly, Monday

Investment Alternatives Matrix | Weekly, Tuesday

MBS Prepay Commentary (October) | Monthly, 5th business day

SBA Prepay Commentary (September) | Monthly, 10th business day

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