Publications /

A Possible Tug-of-war Between the Fed and the Markets
March 25, 2021

The projections for United States GDP released by the Federal Reserve on March 17, pointed to a growth rate of 6.5% in 2021, well above December’s 4.2% forecast. Congressional approval of the Biden administration’s $1.9 trillion fiscal package and the vaccination march against COVID-19 explain the rise in the estimate. However, it should not be forgotten that growth in 2021 will follow a fall in GDP of 3.5% last year.

While the expected unemployment rate at the end of 2021 is now 4.5%, instead of the previous 5% projection, the median inflation rate measured by its core (price index of personal consumption expenditure, PCE) expected by members of the Fed’s monetary policy committee rose to 2.2%, above the December 1.8% forecast, but only slightly higher than the 2% on average that now serves as a target under the Fed's new monetary policy framework announced in 2020 (Table 1).


Table 1: Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, under assumptions of projected appropriate monetary policy, March 2021

Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, under assumptions of projected appropriate monetary policy, March 2021

Source: Federal Reserve (2021), Summary of Economic Projections, March 17.


For that reason, the opinions of participants in the Federal Open Market Committee (FOMC) meeting on how long the current basic interest rate (between zero and 0.25%) will remain were spread between 2022 and until 2024. At the press conference after the committee meeting, given by its president, Jerome Powell, the signal of a continuity in the immediate future of the accommodative policy approach was reinforced, including a continuation of the Fed’s purchases of Treasury bills.

It should be taken into account that the impact of the Biden fiscal package is what analysts call a ‘sugar rush’, or a short-term burst of energy. A second infrastructure package is planned, but the effect of the tax package now approved will be a one-shot stimulus, instead of creating lasting demand in the economy. Not surprisingly, on average, committee members said they expected core inflation to be 2% in 2022 and 2.1% in 2023.

What about the yields on long-term US Treasury bonds? They fell slightly after the projections were released on March 17, but there is evidence that volatility will continue.

There appears to be a double divergence between the market and the Fed. The inflation projections embedded in bond prices remain above those presented by the Fed. In addition, there appears to be a discrepancy between the mode of action announced by the Fed and what the markets predict as the Fed’s ‘reaction function’.

There is also some discomfort on the part of investors because anticipating movements in basic interest rates became more complicated after the Fed stopped using 2% as a kind of ceiling and the rate became an average. How much and for how long would inflation above 2% become a trigger for tightening monetary policy?

Anyone following Fed officials' pronouncements may have noticed the presence of deep-seated doubts over the past few years. What is the degree of flattening of the Phillips Curve? In other words, how long can the economy stay warm without full employment of labor? What exactly does such full employment correspond to?

In an article for Bloomberg, Jerome Powell referred to unemployment in the Black population, increases in wages in the low-income brackets, and workers with no college education. As in other parts of the world, there is a call for central banks to look at broader sets of indicators than isolated inflation indices as a sole benchmark for economic and financial stabilization. The straight use of aggregate projections for unemployment and inflation has proved tricky, as the world seems to have become too complicated to fit simple rules regarding such variables.

In New Zealand, a pioneer in formalizing the inflation-targeting regime, real estate prices are now included. Let us remember the fever that followed the 2008 global financial crisis about the possible expansion of the range of monetary policy, in combination with prudential regulation, to also keep an eye on the prices of financial assets, instead of simply focusing on prices of goods and services.

Will there be a tug of war between the Fed and the Treasury's long-term bond markets? The 10-year rise in market yields this year has been more pronounced than in previous times of instability, such as the 2013 taper tantrum and the sell-off of government bonds in 2003 and 2015 (Figure 1). Demand for US Treasury bonds has reduced since the beginning of the year, judging by auction prices, suggesting to some that “bond vigilantes” are policing and punishing fiscal policy considered too loose.


Figure 1 – Unprecedent spike in 10-year US Treasury bond yields

Unprecedent spike in 10-year US Treasury bond yields

Note: 100 = start of bond sell-off, trading days since start of the sell-off

Source: Ortlieb, P. (2021), Fed can crush ‘bond vigilantes’ if it chooses, OMFIF, March 17.


The Fed announced Friday that it will not extend beyond March 31 the easing of banks’ minimum capital rules, which was granted in April 2020 during the financial shock of the start of the pandemic. The permission to temporarily exclude bank reserves of Treasury bills and deposits with the Fed from bank assets requiring coverage in terms of minimum capital will cease to apply.

What about the discrepancy between the Fed's narrative and long-term market yields? How proactive will the Fed have to be in convincing markets? At the Fed meeting in June 2020, the possibility of “controlling the yield curve” was ruled out because it was “not clear that the committee would need to reinforce its forward guidance” with the adoption of such a policy. The Fed's current complacency in relation to long yields can always be superseded by a revision of such a position for the sake of stabilization, if volatility increases in the long part of the yield curve.


The opinions expressed in this article belong to the author.



  • February 8, 2024
    Depuis 2016, on assiste à une dynamique de création de fonds souverains africains. En 2023, on recense 21 pays et 24 fonds souverains. Sur la seule période 2016-23, celle de la deuxième vague, huit pays vont se doter d’un premier fonds souverain, et d’un deuxième, dans le cas du Maroc, en 2022. Cette étude rappelle tout d’abord l’historique d’une création qui commence, dès 1994, au Botswana, avec le Pula Fund, précisant pour chacun des 24 fonds leur date de création, leur ...
  • Authors
    January 12, 2024
    A 2023 United Nations progress report (UN, 2023) showed that, of the 169 targets that make up the Sustainable Development Goals (SDGs), only 15% are on track, and progress on many has either stalled or regressed. The Water-Energy-Food nexus approach has highlighted the utmost importance of understanding the interconnections between systems in order to accelerate the achievement of the SDGs. In this policy brief, we use the lessons learned from the water sector through a case study f ...
  • Authors
    Elhoussaine Wahyana
    January 12, 2024
    The debate on global value chains (GVCs) has emphasized countries’ contributions to value-added creation. From an intercountry perspective, a new body of research is addingto this debate by studying how subnational regions contribute to the indicators in specific countries. Proper assessment of economic contributions is essential for designing incentive policies. This paper analyzes the role played by the main trading partners of Moroccan regions in local value chains. We use input- ...
  • Authors
    January 2, 2024
    The Belt and Road Initiative (BRI), launched by Xi Jinping, passed its tenth anniversary in 2023. It has entered a third phase. The initiative added a label to China’s financing and construction of infrastructure abroad, which had already totaled more than $400 billion in the previous 10 years. In addition to the use of investment projects as part of Chinese ‘soft power’, the BRI has served to increase levels of usage of the country’s excess installed capacity. China’s economic re ...
  • December 26, 2023
    في ختام هذا العام، يُخصص مركز السياسات من أجل الجنوب الجديد حلقة خاصة من برنامجه الأسبوعي"حديث الثلاثاء"، لاستعراض أبرز تطورات الاقتصادية خلال عام 2023. هذا العام شهد تحولات عديدة وتحديات غير اعتيادية ، فكيف أثرت هذه التغيرات على الاقتصادات العالمية؟ وما هو الدور الذي أضافته الجغرافيا ا...
  • December 19, 2023
    يخصص مركز السياسات من أجل الجنوب الجديد حلقة خاصة من برنامجه الأسبوعي "حديث الثلاثاء" لمناقشة اشكالية المديونية في الجنوب : الواقع والافاق. حلقة خاصة في اطار النسخة الثانية عشر لمؤتمر الحوارات الأطلسية الدي ينظمه مركز السياسات من أجل الجنوب الجديد كل سنة، والتي اقيمت بمراكش بعد شهرين م...
  • December 8, 2023
    In this interview, Dr. Harinder Kohli, Founding Director and Chief Executive of the Emerging Markets Forum discusses the escalation of interest rates in the U.S. has consistently instilled a sense of apprehension in emerging markets, given the conventional outcome of capital outflows re...
  • December 5, 2023
    في حلقة هذا الأسبوع سنحاول مناقشة موضوع القطاع غير المُهيكَل في المغرب، أبرز التحديات وأفاق المستقبل. حيث أن ظاهرة العمالة غير الرسمية أصبحت تأخذ حيزا كبيرا في مختلف النقاشات العالمية الدائرة حول مسألة التنمية، والمغرب يعد من بين الدول التي تبقى فيها الظاهرة عند مستويات مرتفعة كون منظو...
  • November 30, 2023
    This Chapter was originally published on Cape Town Chronicles   The history of debt in Africa is a long and painful one. It began in the 1980s, when the public finances of most developing countries deteriorated following two episodes of oil shocks, leading to a "lost decade" of low growth, increased poverty, and political instability. The recovery from the debt crisis only became possible following initiatives in favour of heavily indebted poor countries (HIPC) and the Multilatera ...
  • November 24, 2023
    Debt in the Global South was a key point of discussion during the last annual meetings of the World Bank and International Monetary Fund which took place in Marrakesh on October 2023. Whi ...