Chart of the week

Rising inflation expectations ripple across the markets

Rates and inflation expectations moved higher this week. Our chart looks at why the Fed isn’t concerned, but markets could remain choppy, nonetheless.

March 19, 2021 | 2 minute read

Real interest rates and inflation

Source: Bloomberg Finance, L.P., as of March 18, 2021. Long-run inflation expectations are shown as 5Y-5Y forward breakeven rate. Real interest rates reflect the 5Y-5Y forward breakeven rate less the 10-year Treasury yield.

  • Long-term Treasury rates continued their sharp rise higher this week as the Fed vowed to keep its accommodative policies in place “for as long as it takes.”1 On the back of the Fed reaffirming its accommodative stance, the 10-year U.S. Treasury yield soared as high as 11 basis points on the week and is now up approximately 79 basis points year to date.2
  • Treasury yields have risen this year along with investors’ expectations for faster economic growth – the Fed significantly upgraded its own expectation for GDP growth this year, from 4.2% in December 2020 to 6.5% in March 2021.1
  • Yet inflation has also become an increasingly prominent part of the interest rate conversation. Market-based measures of inflation expectations have reached multi-year highs as investors fret about the forthcoming impacts of massive fiscal stimulus (most notably in the form of $1,400 checks) combined with monetary stimulus that continues to go full-steam ahead.
  • High yield bond returns have been relatively modest but positive (under 1%) in the 3-month stretches when rates rose. But their performance during the subsequent three months has been robust as investors generally tend to focus on the positive macro drivers behind the rate increase.
  • Despite the scary headline figures, however, long-term market-based inflation expectations have remained relatively steady at approximately 2% since Q4 2020, as the chart highlights.3 For their part, Fed policymakers project PCE inflation to rise to 2.2% this year before settling down to its 2% target next year.1
  • Said another way, the Fed and market participants both seem to agree that economic conditions will likely improve markedly in 2021 but express little concern that inflation will start raging out of control. Even with inflation relatively contained now, however, rising rates and the mere threat of inflation have already wreaked havoc across duration-sensitive fixed income investments and could continue to make equity markets choppy as investors rotate out of more inflation-sensitive sectors.

  • Federal Reserve, https://bit.ly/3qXoOsP.

  • Federal Reserve, http://bit.ly/2J3ufoX, as of March 18, 2021

  • Rates and inflation expectations moved higher this week. Our chart looks at why the Fed isn’t concerned, but markets could remain choppy, nonetheless.

The chart of the week and any accompanying data is for informational purposes only and shall not be considered an investment recommendation or promotion of FS Investments or any FS Investments fund. The chart of the week is subject to change at any time based on market or other conditions, and FS Investments and FS Investment Solutions, LLC disclaim any responsibility to update such market commentary. The chart of the week should not be relied on as investment advice, and because investment decisions for the FS Investments funds are based on numerous factors, may not be relied on as an indication of the investment intent of any FS Investments fund. None of FS Investments, its funds, FS Investment Solutions, LLC or their respective affiliates can be held responsible for any direct or incidental loss incurred as a result of any reliance on the chart of the week or other opinions expressed therein. Any discussion of past performance should not be used as an indicator of future results.

This information is educational in nature and does not constitute a financial promotion, investment advice or an inducement or incitement to participate in any product, offering or investment. FS Investments is not adopting, making a recommendation for or endorsing any investment strategy or particular security. All views, opinions and positions expressed herein are that of the author and do not necessarily reflect the views, opinions or positions of FS Investments. All opinions are subject to change without notice, and you should always obtain current information and perform due diligence before participating in any investment. FS Investments does not provide legal or tax advice and the information herein should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact any investment result. FS Investments cannot guarantee that the information herein is accurate, complete, or timely. FS Investments makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information.

Any projections, forecasts and estimates contained herein are based upon certain assumptions that the author considers reasonable. Projections are necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the projections will not materialize or will vary significantly from actual results. The inclusion of projections herein should not be regarded as a representation or guarantee regarding the reliability, accuracy or completeness of the information contained herein, and neither FS Investments nor the author are under any obligation to update or keep current such information.

All investing is subject to risk, including the possible loss of the money you invest.

Search our site