Relative to consensus views, I think interest rates will undershoot the 2%. I do not have an exact target for interest rates, so I am not able to give you a range of where the 10-year is by year-end 2021. Thus, the key question, in my view, is whether US rates are above or below consensus, I think rates will undershoot.
1- CPI does not influence rates, despite this being the central factor for consensus seeing higher rates
2– Rate of change matters more (aka ROC)
3– ROC of GDP growth and ROC of inflation breakevens
4– If ROC is flattening, rates have downside risk, not upside
CPI YoY, even ROC of CPI does not really impact rates as much as you think
Many of my colleagues that I speak financial news rather than AI or ML to, have told me that interest rates are set to rise because inflation is rising. Intuitively, this makes perfect sense. In fact, if you asked me what drives rates, it is two components:
– real cost of rate (Fed, deficits)
But the “inflation” is actually the forecasted inflation in Fed’s mind, matching the duration of the interest rate. So arguably, CPI doesn’t matter, unless that is the level of future inflation rates.
In other words, current/contemporaneous CPI should not drive interest rates. And the below chart shows this to be indeed true. CPI, or rather ROC of CPI has little impact on interest rates.
– so unless one believes current CPI YoY inflation is sustained for the next 10-years
– CPI YoY has little impact on interest rates
What do you think?