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What Made Markets so Happy about Yellen’s Testimony?

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Part 5
What Made Markets so Happy about Yellen’s Testimony? PART 5 OF 8

Low US Inflation: A US Federal Reserve Nightmare

Yellen’s view of inflation

In her recent testimony to Congress, US Federal Reserve Chair Janet Yellen affirmed the view that inflation is expected to stabilize near its medium-term target of 2%, though the annual pace of inflation is still below that target. In its monetary policy report, Fed has acknowledged the slowdown in inflation in the most recent quarter and said that this slowdown is idiosyncratic.

Inflation in May was reported to have grown at 1.4%, which was far below the Fed’s target, and this fall in inflation (TIP) has impacted bond markets (BND).

Low US Inflation: A US Federal Reserve Nightmare

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Oil prices and inflation

Falling global crude oil prices had a huge influence on inflation last year, but prices have begun stabilizing in recent months. The Fed expects that stable or increasing crude prices (USO) will help inflation stay stable in the near term.

Core inflation numbers, which exclude food and energy, also show that there has been a marked slowdown in this metric as well, with a 1.4% rise in May.

Yields and inflation

Long-term inflation has not changed much recently, and this has led the yield curve to flatten in bond markets. With long-term inflation expectations remaining stable and the interest rate outlook turning bearish, yields at the shorter end (SHY) of the curve are responding more than bonds at the longer end (TLT) of the curve, leading to a flattening yield curve.

Overall, inflation is still a worry for the US central bank, and future Fed actions will depend on inflation reaching its 2% target level.

In the next part, we’ll analyze the Fed’s view of market vulnerabilities.

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