Markets react to inflation projections as the Fed maintains course on interest rates
Summary
March Madness is in full swing in the financial markets, with brackets already busted as investors reacted last week to growing concerns of inflation risk while the Fed announced rates are likely to remain at current levels through 2023.
Economic outlook
During last week’s FOMC meeting the Fed significantly increased its economic growth forecast, with expectations for GDP growth to reach 6.5% in 2021, a jump from the previous projection of 4.2% announced in mid-December. FOMC members also announced expectations for unemployment to fall to 4.5%, a sign that the economy may be headed in the right direction towards a recovery from impacts of the coronavirus pandemic. The Fed announced it would likely maintain existing policy levers to hold interest rates at the current near-zero levels through 2023.
Following the announcement, the 10-year Treasury yield increased to 1.75% on Thursday, marking a 14-month high, as both the Dow Jones Industrial Average and S&P 500 also closed Wednesday at record highs. Meanwhile, with vaccinations increasing and a new round of stimulus checks for Americans because of the recent $1.9 trillion relief package, U.S. inflation is expected to rise to 2.2% before the end of the year. Although some investors expressed concern that such rapid growth may lead to sustained inflation, the most recent FOMC dot plot shows no consensus for a rate hike through 2023, indicating that, while the economy may be on the road to a full recovery, there is still work to be done.
(Related insight: Read, "Interest rates continue rising amidst positive inflation data and COVID-19 stimulus")
Market reactions to inflation projections
Markets reacted with choppiness as the Fed held to its new policy framework of average inflation targeting. Although Treasury yields extended recent gains, equity markets seesawed back and forth throughout the day Thursday. U.S. technology stocks were hit especially hard as the NASDAQ dropped 3%, while equities in Asia and Europe were buoyed as a result of the stronger economic growth projections announced by the Fed.
The U.S. dollar index initially fell on Wednesday following the FOMC announcement. However, rising U.S. bond yields helped the dollar rebound and strengthen broadly against major currencies on Thursday. Oil has continued to slip amid expectations of declining demand in Europe, with U.S. crude prices falling more than 7% to $60 per barrel. Meanwhile, gold futures rallied from early losses to post modest gains on Thursday afternoon. However it remains to be seen if precious metal gains will hold up if bond yields continue to increase.
The Fed’s decision to stay the course in light of inflation projections serves as a cautionary reminder to bullish investors that it will take time for the economy to fully recover. Some participants expressed concern that sustained inflation may cause the economy to overheat, resulting in the potential for heightened volatility throughout the financial markets.
(Related insight: Read, "Managing interest rate risk on future debt issuances.")
Week ahead
As Americans continue to receive stimulus payments, investors will continue to closely monitor Treasury-yields and consumer spending trends. On Friday, the U.S. Bureau of Labor Statistics will release the State Employment and Unemployment news release for February 2021.
About the author
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