Fidelity: Fed deemed too lenient, bond yields at highest in 20 years

Rates first. Asset manager Fidelity has published its quarterly market update. Its diagnosis aligns with the climate that briefly pushed Bitcoin below $80,000. The Federal Reserve raised its rates in the third quarter, for the first time since 2023. The yield on ten-year U.S. Treasury bonds has reached its highest level in two decades.

Key points of this article:

• Fidelity believes the Fed's rate remains below its neutral level.
• The ten-year U.S. bond gained 82 basis points in the third quarter.
• Commodities surged by 16.2% while bonds declined.
• The trajectory of the next cycle depends on AI adoption.

Why Fidelity urges the Fed to tighten

The nominal ten-year yield finished the quarter at 5.3%, the highest in twenty years. The increase is mainly explained by real rates, the portion of the yield that remains after 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 factoring in sustainably higher borrowing costs, not a price surge.

For the research team at the asset manager, the Fed needs to tighten further, as its estimate of the neutral rate places monetary policy below the level that allows for stable inflation. Fidelity Report.

It cites inflation remaining above the 2% target for over five years. The Fed's delay also weighs in, as its last hike was in 2023.

The risks listed in the report are symmetrical. A rate hike would not hinder AI infrastructure construction, but it would weigh on real estate and modest households.

Two-speed markets

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

Energy explains most of the movement. The renewed conflict between the U.S. and Iran has reignited tensions in the Strait of Hormuz, and Shanghai crude gained 56% over the quarter. U.S. strategic reserves are nearing their selling limits.

At the same time, AI construction is attracting massive capital, with tech giants issuing 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, disparities are widening beneath the surface. The volatility of individual stocks exceeds that of the index, and the Technology sector now accounts for over 40% of emerging indices. Small caps have dropped by 7.2%.

The unknown remains the scenario, as Fidelity considers AI adoption still early, far below historical waves like electricity or the internet. Its effect on inflation remains to be demonstrated.

The market, for its part, is primarily looking at the next rate decision. Fed, ECB, and BoJ meet this week for three crucial appointments, and Fidelity's report has just set their media calendar.

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