Bond markets sold off in dramatic fashion in January. The 10-year Treasury note yield rose 32 basis points (bps). The yield curve steepened modestly through 10 years, but flattened from 10 to 30 years. Equities posted large gains. The financial markets responded to more positive global economic news, strong earnings domestically, and momentum from the recently enacted Tax Cuts and Jobs Act of 2017.
Behind the increase in interest rates were inflation expectations that continued to creep higher, the dollar that declined further, rising oil prices, and U.S. economic data that was generally positive. Additionally, as tax cuts take hold, increased Treasury issuance looms large as the burgeoning deficit will need to be funded. The prospect of trade skirmishes remains something of a wild card, as Washington seeks to enhance opportunities for domestic manufacturers.
The Federal Reserve’s tone moved slightly to the hawkish side. While the market appears to believe that policy will remain status quo, it is worth noting that Powell has taken over as the new chair, and several previously non-voting board members will rotate into voting roles. Whether the Fed will raise rates three or four times this year is still under debate and has important implications for the shape of the curve. Potential changes to the expected pace of Fed tapering remains a concern for bond investors.