Judging by the recent developments in the US money and Treasury markets investors start to expect that the Federal Reserve will start to normalize policy sooner than expected earlier. If a month ago a first interest rate hike was expected no earlier than the second half of 2023, this month expectations have sharply shifting closer to present time, pricing in a rate hike at the start of 2023. While consumer inflation in the US is dormant, inflation premium in bond yields is rising very quickly, making it more expensive for the US government to use debt markets to finance new stimulus programs. For example, the interest rate on 10-year Treasuries has risen from 0.92% to 1.15% in just a week since the beginning of the new year:

Investors are demanding higher compensation in bond yields primarily due to rising inflation expectations. If future inflation is expected to rise then purchasing power of future stream of payments is expected to decline more. Expected average inflation for the next 5 years as measured via 5y5y inflation swap climbed above 2.0%, but Core PCE (the Fed's preferred inflation metric) is still at 1.4%. The market is running ahead as usual, therefore, if the inflation data for December-January show an acceleration, the market will be hardly surprised as the rise should be priced in:

Although due to discrepancy in expectations and actual inflation, bond markets may express more sensitivity to negative surprises in inflation in the coming months, since in this case the market's error in assessing inflation will be revealed. If consumer inflation slows, Treasury yields may also quickly adjust downward, while extend its trend upwards.

Inflationary expectations are likely to maintain an upward trend, so discussions in the US Congress of new support measures will certainly imply the participation of the Fed in the form of an increase in QE. Otherwise, borrowing another $ 1 trillion (the estimated amount of fiscal impulse that the Democrats will approve) will be problematic, as future debt service costs will increase significantly. The dovish rhetoric of the Fed is known to be a negative signal for the dollar.

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