Benchmark bond yields held near multi-week highs as investors continued to reassess the Federal Reserve’s policy trajectory
What’s happening
The yield on the 2-year Treasury
TMUBMUSD02Y,
3.276%
rose 6.7 basis points to 3.293%. Yields move in the opposite direction to prices.
The yield on the 10-year Treasury
TMUBMUSD10Y,
2.984%
added 1.3 basis points to 2.986%.
The yield on the 30-year Treasury
TMUBMUSD30Y,
3.222%
climbed less than 1 basis point to 3.223%.
The 10-year to 2-year spread of minus 30.7 basis points is narrower than of late but remains inverted, signaling a looming economic downturn.
What’s driving markets
The recent trend for yields is higher again. Ten-year Treasury yields fell from an 11-year high of about 3.5% in June to nearly 2.50% by the start of August on hopes that signs of peak inflation meant the Federal Reserve could slow its pace of rate hikes and even start trimming borrowing costs in 2023.
However, benchmark yields are back up near 3% as many traders reckon the Fed is determined to reaffirm its hawkish credentials. The policy-sensitive 2-year yield is close to a fresh 14-year high.
“The Fed has pushed back consistently against the market’s pricing of a Fed turnaround to easing rates next year with partial success, as expectations for rate cuts have shifted farther out the curve and from higher levels,” said strategists at Saxo Bank.
The Saxo strategists added that the key test for markets this week may come on Friday when the Fed’s preferred measure of inflation, the July PCE inflation data, will be released, and Fed Chair Jay Powell will speak at the Jackson Hole Symposium.
“While the Fed has taken to emphasizing two-way risks around the tightening cycle, most visibly in the minutes at the July meeting, the easing of financial conditions since the July meeting may force the Chair to re-orient expectations away from the balance of risks back toward the primary objective of bringing inflation lower,” said analysts at Deutsche Bank in a morning note.
Indeed, Meghan Swiber, rates strategist at Bank of America, emphasized that factors such as the PCE data remain crucial for determining Fed thinking.
“We believe the Fed will need to see convincing evidence that inflation is well on its way back to target before it is willing to cut rates. The Fed likely does not need to see inflation fall all the way back down to 2% but needs to trust there has been sufficient demand destruction to soon reach its inflation target,” said Swiber in a note to clients.
However, she is more optimistic that a Fed pivot could occur next year: “Cuts in late-2023, as the market and our economists currently anticipate, are feasible under the conditions that inflation declines towards target and we see a moderation in jobs growth.”
Markets are pricing in a 54.5% probability that the Fed will raise interest rates by another 75 basis points to a range of 3.00% to 3.25% after its meeting on September 21st. The central bank is expected to take its borrowing costs to 3.72% by April 2023, according to Fed Funds futures, and begin cutting towards the end of that year.
