Our view on the trajectory of U.S. rates is that they will move higher for the year, driven by expectations of solid growth as the economy fully reopens, prospects for additional fiscal spending, higher inflation expectations, easier financial conditions, and looming Treasury issuance. On the monetary policy front, we expect a patient Federal Reserve. Policy rates will likely be maintained at zero, as we think the Fed will remain focused on supporting the recovery. This is a recipe for rising rates, but more a gradual shift higher in rates rather than a dramatic repricing.
The move higher in interest rates to start 2021 has been primarily a U.S. phenomenon. In our view, the driver has been the recent Georgia elections, which have increased expectations of a faster closing of economic slack (via more aggressive fiscal spending) and have forced investors to consider an early Fed taper scenario. We agree that fiscal spending will be more aggressive than previously thought given the election results. However, we also believe pricing for a “Fed taper” is very premature. While we’ll likely continue to see some one-off comments suggesting that the Fed may be considering these types of changes, our strong view is that the center of gravity for the Fed is maintaining these programs until the recovery is well anchored.
In terms of managing portfolio durations and risk levels, our focus will be on the path of inflation/inflation expectations and the Fed’s implementation of its new average-inflation targeting framework. The Fed wants to see a gradual repricing of nominal yields, in our opinion, and we’ll be watching for developments that could upend momentum in risky assets.
Here is our approximate expectation for the path of the U.S. 10-year yield through the year: