(Bloomberg) -- Janet Yellen's patience when it comes to inflation is giving bond bulls more ammunition.
Easy financial conditions, persistent strength in the labor market, and a buoyant global backdrop give the Federal Reserve faith that inflation will return to its 2 percent target -- and all the justification needed to continue with rate hikes, Yellen said Tuesday in a defense of the central bank's hawkish policy pronouncements this month.
That's spurring fixed-income strategists at Rabobank and BMO Capital Markets to make the case for low long-dated yields. They cite the prospect that the Fed is implicitly targeting a lower inflation rate, and thereby risks marginally slowing down output and price pressures down the road.
"Yellen's openness as regards the lack of clarity surrounding the Fed's inflation outlook whilst also highlighting a bias to hike rates gradually, regardless, is negative for the front-end Treasuries, but much less so for longer-dated bonds," says Richard McGuire, chief rates strategists at Rabobank. "And potentially it's supportive given this lack of clarity lends itself to concern the Fed is ‘getting ahead of the curve' in terms of anticipating a recovery of inflation that may never materialize."
The spread between 30-year Treasury yields and their two-year counterparts trended lower after the central bank unveiled plans on Sept. 20 to begin shrinking its balance sheet next month, hitting a cycle low on Wednesday.
While the Trump trade gets a tentative boost spurred by the tax plan from the White House, yields on longer maturity debt remain relatively well-anchored thanks to doubts over the trend of low inflation and a falling ceiling for the Fed's policy rate. Market-implied odds of a rate hike by year-end are now at 70 percent.
The Fed's apparent commitment to snub subdued core price pressures as they keep interest-rate projections for 2018 intact won't derail the Treasury bull market, according to Ian Lyngen, rate strategist at BMO Capital Markets.
"The data doesn't support tightening, but they are using easy financial conditions as an excuse, or reason, to tighten," he says. "Specifically, she essentially said she will be ignoring the post-hurricane data and the lowflation prints -- that risks slamming on the brakes of the real economy, which slows inflation."
He projects the 30-year bond yield will tumble to 2.6 percent by the third-quarter of next year from 2.88 percent currently.
"Relative to the counterfactual, greater patience (which implies more hawkish policy for low-inflation economies) modestly lowers actual inflation in the future," Citigroup Inc. economists led by Ebrahim Rahbari wrote in a report Wednesday.
To contact the reporters on this story: Sid Verma in London at sverma100@bloomberg.net, Luke Kawa in New York at lkawa@bloomberg.net.
To contact the editors responsible for this story: Samuel Potter at spotter33@bloomberg.net, Dave Liedtka, Andrew Dunn
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