Chart of the Week: Bonds rally amidst Fed policy change expectations

The final few months of 2023 saw a remarkable rally in the US bond market, with yields falling to levels not seen since last July. According to Fathom analysis, long-term rates had been driven higher until that point largely by monetary factors, such as the level of the policy rate and the volatility of both the policy rate and inflation, rather than by fears about the US fiscal position, or views about the equilibrium real rate of interest. Our central scenario for the US economy is one of ‘immaculate disinflation’, where inflation continues to fall as inflation expectations adjust, rather than by way of recession. This is likely to permit a material easing of US monetary policy. Investors are also pricing in a series of cuts this year, with these beliefs fuelled by the recent release of the median projections of the policy rate by the Fed. We expect US yields to continue to fall this year (and by more than is currently priced in) as the volatility of both the policy rate and inflation falls, facilitating a lower term premium.

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The views expressed in this article are the views of the author, not necessarily those of LSEG.

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