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‘Higher volatility’ expected with Fed pullback: Charles Schwab Chief Strategist

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With inflation reaching a 31-year high in light of persistent supply crunches plaguing consumer durables as well as rising wages and rents, all eyes are on the Fed as analyst timelines for the first rate hikes pull forward. According to Charles Schwab (SCHW) Chief Fixed Income Strategist Kathy Jones, greater volatility and slowing growth can be expected once the Fed completes the tapering process and raises rates.

“Whenever the Fed pulls back on this really easy monetary policy, you start to see higher volatility,” Jones told Yahoo Finance Live. “And likely what we're going to see is short-term rates go up, long-term rates sort of trail behind so you get a flatter yield curve. And that sends a signal of slowing growth on the horizon.”

Jones went on to elaborate on how she thinks volatility is going to manifest itself within fixed income markets.

“[These dynamics make] it tough for, say, corporate bonds, especially high yield bonds, and bonds that really depend on that easy liquidity in the market. So that's what we mean by more volatility,” she said. “Right now, those yields are very low, and especially low relative to Treasuries. And I think that investors will demand a higher risk premium if we go into a different kind of economic environment in the second half of 2022.”

As for current investor sentiment within fixed income, Jones said that yields are not too attractive for buyers due to inflation concerns, with investors mainly choosing to keep their money in short-term bonds for the time being. Only when inflation rates are reeled in does she believe confidence to invest in longer term bonds will return.

Federal Reserve Chairman Jerome Powell testifies before the House Financial Services Committee during a hearing on Capitol Hill in Washington, U.S., September 30, 2021.  Sarah Silbiger/Pool via REUTERS
Federal Reserve Chairman Jerome Powell testifies before the House Financial Services Committee during a hearing on Capitol Hill in Washington, U.S., September 30, 2021. Sarah Silbiger/Pool via REUTERS

Jones joined Yahoo Finance Live to discuss her outlook on markets amid record levels of inflation. Chicago Federal Reserve President Charles Evans said on Wednesday, Nov. 17, that the taper is going to take until mid-2022 to complete. The Fed began reeling in its bond purchases this month at a pace that would have it completely phasing out purchases by next June.

Experts anticipate that surging inflation may cause the Fed to act earlier than previously expected in raising rates — as early as July, soon after the taper process is completed.

“We have the Fed pulling back on excess liquidity with the tapering program,” Jones said. “We expect them to probably raise rates once in 2022 in the second half of the year in order to catch up with where trend growth and inflation are.”

Although she feels that much of the anticipation of rate hikes has already been “built in” with regard to treasury yields, when the Fed does raise rates, Jones expects a flattening of the curve as short-term rates outpace the longer term.

“I think when it happens, what you'll start to see is short-term yields will move up across the yield curve, but longer term rates will not rise as fast as short-term rates,” she said. “And you get that flattening of the yield curve. That's typically what you see when you enter a tightening cycle.”

Thomas Hum is a writer at Yahoo Finance. Follow him on Twitter @thomashumTV

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