Pimco’s Ivascyn Says Fed Will Act on Inflation as Yields Spike

Dan Ivascyn Photographer: Kyle Grillot/Bloomberg Photo by Kyle Grillot /Bloomberg

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(Bloomberg) — The Federal Reserve and other major central banks will have to take action if inflation expectations rise further as a surge in global bond yields risks triggering broader financial market turmoil, says Pacific Investment Management Co.’s chief investment officer.

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Treasury market expectations of inflation, known as breakeven rates, recently climbed to the highest levels in more than three years as oil prices shot higher after the US attacked Iran in late February. The move has fueled a sharp selloff in global bond markets, propelling the US Treasury 30-year yield this week to its highest level since 2007. 

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If long-dated inflation expectations “become more significantly unanchored, then you are going to see a tightening of policy even in the face of some economic weakness,” Daniel Ivascyn said in an interview. “That’s the pain trade for markets,” as rates would climb and increase pressure on equities and credit. 

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The prospect of tighter policy sets up a challenging backdrop for incoming Fed Chair Kevin Warsh, who’s taking the helm this month after a campaign from US President Donald Trump for lower interest rates. 

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While the central bank has held rates steady so far this year, officials have grown increasingly divided over the monetary policy outlook. At the April meeting, policymakers argued that while the near-term inflation outlook faced upside risks, “longer-term inflation expectations remained well anchored.”

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That’s even as popular Treasury inflation benchmarks are at levels seen back in March 2023 when the Fed was still raising rates to curb the post-pandemic inflation surge and an energy shock from the Russian invasion of Ukraine. The US 10-year breakeven has traded above 2.5%, after starting the year around 2.2%, while a popular forward US breakeven still holds within ranges after also climbing in recent weeks.  

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In contrast, corporate credit and equities have held up as US economic data have been resilient, even as bond traders ratcheted up Fed rate hike expectations. Swap contracts have nearly priced in a quarter-point rate hike by the end of the year. 

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Ivascyn said risk asset performance has been “a little surprising on the margin.” 

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“It has been very profitable to buy equity and credit dips for about 15 years,” he said. Treasury “yields could go higher, but we think it’s hard for them to go materially higher without it beginning to significantly impact risk markets.”

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The rapid pivot by traders to price in central bank rate hikes has increased the appeal of junk debt that’s typically shorter in maturity and therefore less sensitive to rising yields. But with junk spreads not far from the 2007 lows, budding stagflation risks and rising defaults in private credit, some investors are questioning the exuberance that allowed even several of the riskiest borrowers to tap markets recently.

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Tighter policy “could lead to some stability in long term rates as the market receives a signal in terms of the desire to get inflation expectations back in check,” Ivascyn said. He still sees the amount of tightening currently embedded in most curves as “probably excessive.”