Fed: Five reasons to taper - DBS Bank

Fed: Five reasons to taper - DBS Bank

FXStreet notes that after consolidating for the past two months, USD rates are starting to stir amidst more intense inflation debates – 10Y US-T yields swung from a low of 1.46% to a recent high of 1.70%. Economists at DBS bank list five reasons why taper is coming, sticking to the view that 10Y US yields can touch 2% this year and head into the 2-2.5% range thereafter.

“Financial conditions are benign. Stresses in the various markets are contained, with implied volatilities in equities and swaps on the low side. Credit and liquidity risks are extremely low in the money markets.”

“Vaccinations are going well in the Developed Market space. At the current pace of vaccination (about 10mn shots per week), the US would be on track to achieve herd immunity (close to 70% of population vaccinated) by July. This would allow segments of the economy that previously were unable to normalize to finally stage a meaningful recovery.”

“Inflation is uncomfortably high. Sequential inflation of 0.8% MoM and a YoY figure of 4.2% can be difficult to ignore. We would note that core inflation is also much higher than what consensus expected. While April is just one data point, there are concerns that a broadening out of price pressures could take place in the coming months. While realized inflation is important, we do think that the Fed has to pay attention to more timely indicators.”

“The labour market is strong, notwithstanding the payrolls stumble in April. To be sure, we are probably not at the Fed’s hurdle where taper is imminent. The economy has recovered about two-thirds of the jobs lost during the Pandemic and the U3 unemployment rate of 6% probably flatters the labour market situation. We reckon that actual unemployment is probably a tad above 8% but this adjusted figure can quickly fall if we get another 2-3 months of strong payrolls. This could set the stage for a Fed pivot in late 3Q.” 

“There are signs of excess liquidity and that is probably contributing to froth in selected assets as short-term USD rates get anchored. It is probably easier to taper asset purchases to manage the unwanted influx of liquidity. In any case, UST issuances may have peaked with Pandemicrelated spending likely to ease towards the end of the year. There may not be as strong a need for the Fed to absorb incoming bond supply towards late 2021.”

“We see compelling reasons for taper and expect the Fed to pivot (signal) later this year. We reiterate our above consensus 2% 10Y US yield forecast for 2021.”