A recent spike in U.S. bond yields has come alongside muted expectations for inflation, a sign to some bond fund managers that economic resilience and high bond supply are now playing a larger role than second-guessing the Federal Reserve. Bond yields, which move inversely to prices, tend to rise in an inflationary environment because inflation erodes the value of a future bond payout. But while higher moves in bond yields in the last several months were often driven by investors pricing in higher interest rates as the Fed sought to tame rising inflation, expectations on the pace of price rises have moved lower in recent weeks.
FILE PHOTO: The U.S. Federal Reserve building in Washington, D.C.NEW YORK - A recent spike in U.S. bond yields has come alongside muted expectations for inflation, a sign to some bond fund managers that economic resilience and high bond supply are now playing a larger role than second-guessing the Federal Reserve.
But while higher moves in bond yields in the last several months were often driven by investors pricing in higher interest rates as the Fed sought to tame rising inflation, expectations on the pace of price rises have moved lower in recent weeks. While the timing and size of the central bank's monetary tightening actions have preoccupied bond investors for well over a year, the market may have reached "an inflection point in terms of the primary driver of sentiment," BMO Capital Markets analysts said in a note last week.
"We’re pricing in a soft landing, which means we’re seeing things working out in the Fed’s favor, as inflation is coming down and the probability of a recession has been reduced," said John Madziyire, senior portfolio manager and head of U.S. Treasuries and TIPS at Vanguard Fixed Income Group. Yields are also a reflection of expectations around the so-called neutral rate - the level at which interest rates are neither stimulative or restrictive for the economy. A recent string of strong economic data despite higher interest rates has strengthened investor beliefs that interest rates will remain higher for longer, even if inflation is tamed.
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