May 30, 2023

Our outlook is that as the inflation rate approaches the 2% target range, we expect the T-bill yields to stabilize. At the long end of the spectrum, the interest rates are driven by more than inflation, the pace of economic activity matters a great deal. Since the economy has shown signs of weakening, the long-term bond yields have declined. The combination of slower growth and declining inflation rate have contributed to the decline in bond yields. Since the beginning of the year these two variables have moved in tandem. But we do not expect that to continue on for long. The trend in the inflation rate points to a slowdown or less aggressive Fed stance. The deceleration in M2 supports this view. Then, at some point, we expect the economy to return to its normal trendline and with some luck even surpass the “new normal.” This expected divergence between the growth rate and inflation rate should result in a higher bond yield and a normalized yield curve.

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