In January, volatility returned to the rates market in a big way. The benchmark 10-year Treasury note yield rose from 1.48% at the end of the year to as high as 1.88% mid-month before settling at 1.77% to close out January. The 2-year Treasury rate increased 41 basis points (bps). The yield curve flattened by any measure: 2-10s, 5-30s, 10-30s were all lower on the month. Real yields rose significantly as well; 5-year TIPS yields were up 36 bps. Rate moves were largely a function of inflation and the Fed’s potential reaction to it.

The Fed’s recognition that inflation was not transitory morphed into a view that inflation could indeed be a major problem. Economic data underscored the inflation issue, as prices, especially oil, rose. Wages followed, despite a labor participation rate still much lower than pre-pandemic levels. Market expectations of Fed Funds rate increases shifted to close to five hikes during 2022, with some arguing that a 50 bps hike could potentially come in March. Beyond rate increases, the market began focusing on the potential for a speedier reduction in the size of the Fed’s balance sheet. For his part, Fed Chair Powell acknowledged that a March rate hike was clearly on the table but was largely non-committal regarding the pace of Fed actions, particularly regarding the balance sheet. Lingering in the background was a spike in Omicron variant COVID-19 cases and heated tensions over the Ukraine

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