2021 Midyear Outlook: Navigating through the recovery
Listen in as we discuss our outlook on the US recovery and the Federal Reserve’s new framework, including its impact on inflation, interest rates and growth.
We recently highlighted our thoughts on tapering in early 2022 and the possible direction for interest rates. Here are additional thoughts on the topic.
We believe the Federal Reserve (Fed) will begin tapering its asset purchase program, currently at $120 billion per month, in January 2022 and complete tapering by the end of year. We expect the first interest rate hike of the cycle to occur in the second quarter of 2023. We think the risk to this forecast is for the Fed to act sooner, and think the market is currently underestimating how much the Fed will have to hike interest rates, once the rate hike cycle starts.
As we highlighted in a previous “Chart of the week” discussion, if the Fed is successful in generating inflation, we think this could bring about higher nominal gross domestic product (GDP) growth than the US economy experienced in the last cycle. This has potential implications for market interest rates and risk assets.
In the previous post, we discussed the slope of the yield curve and implications for investors. The absolute level of yields also warrants attention. 10-year US Treasury yields typically rise further once interest rates hikes commence, as they historically have moved in the same direction as nominal GDP over time. While we would not necessarily expect 10-year yields to move as high as our forecast for nominal GDP growth of between 4 and 4.5% in this cycle, we believe that over the medium term, yields should move higher from here.
Chart source: Macrobond. The blue line represents the target interest rate set by the Federal Open Market Committee (FOMC) at which commercial banks borrow and lend their excess reserves to each other overnight. The green line represents the 10-year US Treasury Constant Maturity Yield. Dates shown are January 1, 1990 to July 1, 2021.
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