Financial Association News on September 26th (Editor Xiaoxiang) There are signs that the Federal Reserve's active initiation of a loose cycle is reigniting concerns about inflation in the US bond market, as some investors are worried that the loose financial environment may rekindle price pressure.

As we introduced earlier this week, the longer-term US Treasury bond yields, which are particularly sensitive to inflation prospects, have recently risen to the highest level since early September. In particular, the 10-year US Treasury bond yield, known as the 'anchor of global asset pricing,' has risen after the Federal Reserve's significant rate cuts instead of falling, as some investors are concerned that the Federal Reserve will shift its focus from suppressing inflation to protecting the job market, which may cause inflation data, which has not fully returned to the Federal Reserve's 2% target, to rebound.

Cayla Seder, macro multi-asset strategist at Charles Schwab Global Markets, said, 'I believe that if we are in a rate-cutting environment and the Federal Reserve has indicated its desire to provide more support for employment before the labor market weakens, then the speed at which the inflation rate reaches the Federal Reserve's target will become a question.'

She expects that as the market bets on economic growth and strengthening inflation, long-term bond yields will further rise.

Federal Reserve Chairman Powell stated at last week's post-meeting press conference that the 50 basis point rate cut to start this round of Federal Reserve easing is a 're-adjustment' of interest rates, aiming to maintain a strong labor market while sustainably moving the inflation rate towards the Federal Reserve's 2% target. The Federal Reserve officials' dot plot also indicates that the pace of rate cuts will be relatively slower than market expectations.

However, traders in the bond market soon began to express concerns about inflation.

The 'inflation ghost' reappears in the bond market

After the Federal Reserve announced a rate cut last Wednesday, the future ten-year inflation expectations measured by Treasury Inflation-Protected Securities (TIPS) have risen significantly. As of this Wednesday, the 10-year breakeven inflation rate has risen to 2.18%, the highest level since early August.

Last Thursday, the U.S. Treasury continued to issue $17 billion of 10-year Treasury Inflation-Protected Securities (TIPS), with investors flocking to it. The allocation ratio for non-primary dealers (direct bidders + indirect bidders) reached a high of 93.4%, the highest level since January.

Bank of Montreal Capital Markets (BMO Capital Markets) interest rate strategist stated in a report last week, "Investors are once again concerned about the ghost of re-inflation."

Ruffer fund manager Matt Smith also noted that over the past few days and weeks, he has been adding inflation protection to his investment portfolio through commodities and commodity equities.

He mentioned that commodities and commodity equities are typical inflation hedging tools and currently have extremely low valuations.

Will the past dismal experiences repeat?

In fact, many in the market still consider the Federal Reserve's policy shift towards dovishness in December of last year, but the memories of the subsequent months of unexpected inflation and job market performance leading to selloffs remain fresh.

The Goldman Sachs U.S. Financial Conditions Index is an indicator of measuring economic credit availability. Despite the federal funds rate remaining at its highest level in over two decades for most of this year, the index has declined during the year, reflecting relatively loose financial market conditions. Especially, on the day after the Fed's September decision, the index dropped to its lowest level since May 2022.

Brendan Murphy, head of Insight Investment's North American fixed income department, said, "We believe that inflation will remain relatively benign... but the more aggressively the Federal Reserve cuts interest rates, the more reason you have to question this."

Measured by CPI, the U.S. inflation rate has indeed fallen sharply in the past two years. In August, the year-on-year increase in U.S. CPI fell to 2.5%, far below the over 40-year high of 9.1% set in June 2022. Federal Reserve Board Member Waller said last week that recent data convinced him that the Fed needs to cut interest rates faster because inflation may fall below the 2% target.

However, at the September meeting, the only dissenting vote was from Fed Board Member Bowman, who expressed concern that a larger rate cut might be seen as "declaring victory too soon" in combating inflation. She opposed the Fed's 50-basis-point rate cut last week and supported a smaller 25-basis-point rate cut.

Some market participants also doubt whether the Fed's significant rate cut is premature because current inflation is still above target, and recent monthly data shows some stickiness in price pressures.

BofA Securities economists mentioned the so-called "Fed put" in a report last week - the phenomenon of the Fed's tendency to come to the aid of the financial markets in critical moments.

BofA Securities stated, given the resilience of the economy and the stock market at historical highs, this time the "Powell put" came too early. They pointed out, "a more aggressive easing cycle may make achieving the 2% inflation target more difficult."

Editor/ping