By Adrian Barbosa, Head Trader and Economist, Banorte Securities
Historically, the U.S. Treasury yield curve tends to be the first mover of all domestic interest rates and an influential factor in setting global rates. Over several months leading up to January 2021, the U.S. Treasury yield trended slightly due to vaccine progress and the expectation of increased stimulus under a Biden administration. They then spiked sharply in February and March as it became clear that the administration would successfully pass one of the largest fiscal stimulus packages in modern history.
Passing a fiscal stimulus package of this magnitude goes beyond replacing income lost due to the pandemic. Generous fiscal support, together with an aggressive vaccination campaign, means the US economy should begin to normalize by the second quarter of the year. In fact, restrictions are already being reduced in some regions, and the labor market is improving. For this reason, markets are looking beyond the pandemic. These factors should result in a moderately higher inflation profile, and may bring forward both tapering of bond purchases and an eventual rate hike. These developments led us to raise our interest rate forecasts in early February.
At the same time, the strong Fed’s response to the pandemic and the large output gap created by the drop in economic activity continue to hold down interest rates. Inflation remains restrained, and markets are not pricing Fed interest rate hikes for several years. The Fed is anchoring short-term rates close to zero, and this has helped sustain the steepening of the yield curve since the beginning of the pandemic. Policy is the most important driver of long-term interest rates, so while economic normalization may cause the Fed to raise interest rates, it will likely do so gradually due to their active management of interest rates, balance sheet and ongoing asset purchases to suppress market volatility.