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Can We Drive Inflation Higher? Traders Are Doubtful Of Powell

Inflation Higher
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EDITOR NOTE: As we mentioned in a corresponding curation, Morgan Stanely’s economist Ellen Zentner, believes that “this time is different” in that the Fed may finally succeed in pushing inflation well beyond the 2% mark. Treasury traders, on the other hand, have cast doubt that the Fed can actually pull it off, as nominal 10-Year yields continue to sink, still hovering well above its March 0.36% lows. As the massive wealth transfer between economic elites and average Americans continues to reach new heights, those on Wall Street are saying through their market actions that “the Fed certainly can do more.” Wednesday’s FOMC announcement will almost certainly confirm this.

(Bloomberg) -- The Treasury market has set a high bar for the Federal Reserve to jump in order to recharge inflation expectations and upend a bullish tone that has surfaced since Chair Jerome Powell laid out a new plan to allow consumer prices to run hot.

Bond-market gauges of inflation expectations have declined for the past two weeks, signaling traders are demanding that Fed policy makers deliver more information about how they will engender a rise in inflation. Benchmark 10-year yields have fallen to below 0.70%, helped also by haven demand as lofty U.S. stock prices turned lower.

Many economists predict Federal Open Market Committee members won’t take any new actions when they wrap up a two-day gathering on Wednesday, an outcome likely to embolden bond bulls and further crimp inflation expectations. Fresh projections for the federal funds rate -- bumped out a year to 2023 -- are expected to show rates hammerlocked at zero, something traders have mostly priced in already. Also on the docket this week are sales of 20-year bonds and inflation-linked debt, with a read on retail sales being the highlight of economic data.

“The market definitely needs more from the Fed now,” Aneta Markowska, chief U.S. financial economist at Jefferies, said by phone. “The Fed will be undershooting on inflation for the better part of four years, so why wait to do more? And inflation expectations have already been fading.”

While Markowska says the consensus has coalesced around the idea that the Fed will maintain the status quo this week, she thinks that would be a mistake for the central bank. Jefferies predicts the Fed will detail enhanced forward guidance and plans to skew Treasury purchases more to long-term debt. Markowska and colleague Thomas Simons detailed that in a note titled “Go Big Or Go Home.”

Powell on Aug. 27 said that the central bank will sometimes allow inflation to run above the 2% target to make up for prior undershoots, and also let unemployment run lower than officials had previously tolerated.

The Fed is buying about $80 billion of Treasuries and $40 billion in mortgage securities a month, both meant to sustain smooth market functioning after pandemic fears triggered a severe bout of illiquidity in March. Its Treasury purchases are being spread across the curve with no bias toward any particular maturity area.

Ten-year breakeven inflation rates –- derived from yields on standard and inflation-linked Treasuries -- have fallen for the last two weeks to about 1.67%. That’s down from an eight-month high of 1.82% reached on Sept. 1. Meanwhile, the gap between 5- and 30-year yields has edged down to 116 basis points, from as high as 125 basis points at the end of last month. Still, August’s core consumer price index, which excludes food and energy, came in higher than expected at 1.7% on a year-over-year basis on Sept. 11.

Benchmark 10-year Treasury yields have also booked two consecutive weeks of declines to hover at about 0.67%. They are headed to 0.60%, predicts Tony Farren, managing director at broker-dealer Mischler Financial in Stamford, Connecticut. He expects the Fed will not deliver anything new this week so he’ll be keenly focused on what Fed officials predict regarding growth, inflation and rates in their latest round of quarterly forecasts.

“Powell may expand on the new inflation plan a little bit more, but isn’t likely to tip his hand too much,” Farren said. “The Fed also has been downbeat on the prospects of the economy, and I don’t suspect that changes this week. Plus there is just way too much uncertainty for the market to change directions and have a significant selloff,” given questions regarding more fiscal stimulus and the upcoming presidential election.

The path forward on a new stimulus package out of Washington remains dim following a partisan split over a slimmed-down package proposed by Republicans.

Originally posted on Yahoo! Finance

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