US | Fed repricing lowers inflation expectations and lifts the dollar

Summary

While policy rate expectations have risen, lower inflation expectations and term premia cap long-term yields. Warsh’s focus on price stability alongside a massive hawkish shift in the dot plot put concerns over the Fed’s independence to rest, unwinding the debasement trade.

Key points

• Key points:
• The futures market is broadly aligned with a high-for longer outlook on rates: it expects the Fed to remain on hold in July, but now prices in a 60% chance of a 25 bp hike in September.
• The recent evolution of the two-year yield reflects this shift in expectations: it reached 4.2% this week, c. 80 bps above its February level and its highest level in 16 months.
• In contrast, following the mid-May sell-off, long-term Treasury yields have trended lower over the past month, leading to a bullish flattening of the nominal yield curve.
• Inflation expectations have fallen sharply over the past month and the term premium has also declined, partly offsetting the policy expectations shift.
• The case for high rates—amid well-anchored inflation expectations—has bolstered the dollar's relative appeal. Since mid-May, the USD has appreciated roughly 3.5%.

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