US | The yield curve is pricing in more uncertainty around inflation next year

All but one FOMC member voted last week to continue removing monetary policy restriction through a 25bp cut, but the Fed also signaled a slower pace of further adjustments due to the incipient but increased uncertainty about inflation next year.

Key points

• Key points:
• Increased Fed caution led to mixed movements along the yield curve: the 10-year Treasury yield climbed by more than 40 bps to a 6-month 4.6%-high from its early-Dec low.
• The combination of rising long-term yields and continued monetary easing pushed the 10y-3m yield spread into positive territory for the first time in more than two years.
• The rise in long-term yields is largely driven by rising real yields, which suggests that markets are primarily factoring in inflation risk rather than just greater inflation compensation.
• This is further evidenced by the term premium, which has risen by c. 50 bps in 4Q, exceeding the roughly 20bp increase in the expected inflation component over the same period.
• While the futures market had already anticipated a slower pace of rate cuts before last week’s FOMC meeting, it strengthened its view that the Fed will not reach a neutral rate next year.

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