At a glance:

  • Interest Rates Unchanged: The Federal Reserve kept interest rates at 5.25%-5.50% and reduced the balance sheet runoff pace to $25 billion/month, signalling a mildly dovish stance.
  • Inflation Target: Jerome Powell wants more progress towards the 2% inflation goal before considering rate cuts.
  • Monetary Policy Debate: There’s debate on the restrictiveness of US monetary policy; real interest rates are below 1.0%, but TIPS yields are high at 2.3%, suggesting higher capital costs.
  • Future Tightening Uncertain: Economic data will guide further tightening decisions. The 10-year yield is adjusting to a more inflationary environment, with an upward trend expected to continue.

The Federal Reserve left interest rates unchanged in April at 5.25%-5.50%. Jerome Powell communicated his preference to see more progress towards his 2% inflation goal before considering a rate cut. He also announced a reduction in the pace at which the Fed balance sheet would be run down, from $60 billion/month to $25 billion/month. Net-net, it was a mildly dovish policy update.

There is an ongoing debate regarding the restrictiveness of US monetary policy today. Real interest rates (10-year nominal rates adjusted for inflation) are less than 1.0%, suggesting monetary policy may still be relatively loose. However, the TIPS (Treasury Inflation-Protected Securities) yield is significantly higher at 2.3%. While the real interest rate is a theoretical construct representing the cost of borrowing in real terms, adjusted for inflation, the TIPS yield reflects the market’s expectations of future inflation and the risk premium associated with inflation-indexed securities.

The TIPS yield is approaching the October 2023 cycle highs, indicating a higher cost of capital. Yet economic growth and stock market barometers suggest that monetary policy is not tight enough. Overall, there is some uncertainty around how tight monetary policy is. While the Fed has tightened aggressively, there are differing views on whether their current stance is tight enough to bring down inflation without derailing the economy. The data and economic outlook will likely determine whether further tightening is needed. While the Fed controls the short end of the yield curve, the bond market determines longer-term rates. The 10-year yield is slowly adjusting to a more inflationary world. The trend higher in 10-year yields should continue.