Fidelity: the Fed considered too lenient, bond yields at their highest in 20 years

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The ten-year nominal yield ended the quarter at 5.3%, the highest in twenty years. The increase is mainly explained by real rates, the part of the return that remains once inflation is deducted.

Indeed, over the quarter, real yields increased by 68 basis points, compared to only 14 for inflation expectations. In other words, the market is pricing in permanently more expensive borrowing, not a surge in prices.

For the manager's research team, the Fed must tighten further, because its estimate of the neutral rate places monetary policy below the level that allows stable inflation.

She cites inflation remaining above the 2% target for more than five years. The delay of the Federal Reserve also weighs, its last increase was in 2023.

The risks listed in the report are symmetrical. An increase in rates would not slow down the construction of AI infrastructure, but it would hurt real estate and low-income households.

The quarter saw performance gaps explode between asset categories, with 16.2% for oil-driven commodities compared to -7.7% for long-duration bonds.

Energy explains most of the movement. The renewed conflict between the United States and Iran reignited tensions in the Strait of Hormuz, and Shanghai crude gained 56% in the quarter. American strategic reserves are approaching their sales limits.

At the same time, the construction of AI is sucking up massive capital, as digital giants have issued ever more investment grade debt to finance their servers. The report sees this as a new driver of the financial market.

On the equity side, the gaps are widening beneath the surface. The volatility of individual stocks exceeds that of the index, and the Technology sector now accounts for more than 40% of emerging indices. Small caps fell by 7.2%.

There remains the unknown of the scenario, because Fidelity considers the adoption of AI still early, well below historical waves such as electricity or the internet. Its effect on inflation remains to be demonstrated.

The market first looks at the next rate decision. Fed, ECB and BoJ meet this week for three decisive meetings, and the Fidelity report has just set the media calendar for them.

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Machine-translated from French