Janus Henderson: Fed prepares for tapering

Members of the Janus Henderson Fixed Income Team Mitul Patel, Head of Interest Rates (left) and Darrell Watters, Head of US Fundamental Fixed Income (right) share their views on the outcome of the FOMC meeting.

Darrell Watters, Head of US Fundamental Fixed Income
We are in an environment in which the Fed can push the decision to raise interest rates into next year, if necessary. With inflation under control, the Fed is not going to be forced into raising rates. A hike in September is unlikely, and December will be dependent on economic conditions. While we do not anticipate a tightening in the fall, we do believe the Fed will begin balance sheet reduction in September. However, the pace of tapering should be moderate, and we anticipate minimal impact on both US Treasuries and mortgage-backed securities.

For the foreseeable future, we expect a lower-for-longer rate environment and a sideways grind in fixed income markets. The yield curve will likely be range bound, with the yield on the 10-year note between 2% and 2.5% and the yield on the 30-year ranging from 2.75% to 3.25%. Without sustained inflation or oil over $50 per barrel, the 5-year yield is unlikely to climb above 2%. We expect this environment to persist until gross domestic product (GDP) growth and inflation meet and sustainably exceed Fed expectations. However, Fed officials are extremely sensitive to market reactions, and we believe their decisions will ultimately err on the side of caution.

Mitul Patel, Head of Interest Rates
The Fed made no changes to its monetary policy stance and was largely in line with expectations. The statement hinted that balance sheet normalisation would start “relatively soon” and we should expect this to be announced in September.

There were some minor tweaks to the statements on inflation, with an acknowledgment that various inflation measures are running below 2%, while their assessment on the labour market was upgraded to reflect “solid” gains in the job market. The market responded by a rally in government bonds, while the dollar continued to decline against major currency pairs. September’s balance sheet announcement seems likely, but future rate hikes seem more dependent on an improvement in underlying inflationary trends: the market is currently assigning a 50% chance of a rate hike in December.