Interest rates came down to low levels and liquidity became aplenty due to the accommodative monetary policies by world central banks, and the expansionary fiscal policies pursued by the governments. This was a direct response to the economic distress caused by the global pandemic and the resultant fall in employment, output, and demand.
It is a fact of experience that these policies helped a rebound in most of the economies though the sustainability of the same is yet to be established beyond doubt. Now that the rebound is happening and there is a recovery in economic activity more or less to the pre-pandemic levels, it is only natural that a review of the policies may happen in the normal course and the markets would also gradually start adjusting to the changed environment.
The resurgence in growth, the re-emergence of inflation, the fears of an imminent return to liquidity and policy normalisation all contributed to the current spike in bond yields. Generally, they say that the central banks follow the markets when it comes to market rates, that is, the rate movements start happening in the markets ahead of central bank policy announcements. It is such circumstances which have led to the kind of events that we are witnessing in the US as also in some of the other economies.
In addition to all this, the inflationary expectations in some of the major economies have been rising. The potential for higher inflation was shown as quite high in the US, and the Fed had on one occasion brought about a change in the inflation targeting converting it from a 2 percent target to an average of 2 percent, with an implicit connotation that the Fed would be tolerant of a higher than 2 percent price level.
In a general assessment, the US economy still stands the chance of encountering a higher price level. This is further occasioned by the additional fiscal stimulus and the expected spending revival in the coming months. The only speed-breaker is the real unemployment rate which is still at 10 percent, a rate that is close to the level where it was during the great recession. While a little bit of inflation is good for the economy, a gradual rise in rates may help the US dollar currency yield, and thereby support the currency to stay where it is with an improving currency yield.