Federal Reserve Chairman Jerome Powell testified during the hearing of the Senate Committee on Banking, Housing and Urban Affairs examining the quarterly report of the CARES Act to Congress on September 24, 2020 in Washington, DC.
Drew Angerer | AFP | Getty Images
Treasury yields flared on Thursday as players in the bond market wrestled with the Federal Reserve’s willingness to heat up inflation.
The ten-year treasury yield rose from 1.64% late Wednesday to 1.75% Thursday, a 14-month high. It was 1.706% in the afternoon trade.
The rise in yields, which is moving against the price, comes a day after Fed Chairman Jerome Powell reassured the market that the central bank is not ready to reverse its bond purchases and other supportive measures.
While forecasters in the bond market say there has been no development that kicked off the rise in yields on Thursday, it appears the market has focused on the fact that the Fed plans to keep inflation warm.
“I think it’s the bond market that is causing inflation to happen and maybe coming because the Fed assures us that they can live with inflation,” Sonal Desai, chief investment officer of fixed income group Franklin Templeton, told CNBC.
A steeper yield curve
For the time being, the rise in interest rates poses no risk to the economy. According to strategists, yields are still relatively low, especially given the expectation of explosive economic growth this year.
However, the yield movement overnight was particularly large, even though the recent rise in yields is ten years, which was 1.07% six weeks ago. The ten-year benchmark is widely watched as it affects the mortgage rate and other consumer and business loans.
The bond market barely moved Wednesday afternoon after the Fed issued its 14:00 ET statement and after Powell briefed the media.
Desai noted that the effect of the market response will be a tighter yield curve, which simply means a larger spread between yields of different maturities, such as the 2-year treasury notes versus the ten-year.
A steeper curve is often seen as a positive sign for growth, while a flat curve can be a warning.
Ralph Axel, Bank of America’s US tariff strategist, said the market reacted on Wednesday to one part of the Fed’s statement, which sent a mixed message.
“The first message that surprised people was that ‘we do not believe in increases in 2023,'” he said. “I think that was where the initial focus was, and I think it retained the attenuation of the initial response.”
The second message was that the Fed would keep the interest rate, warm the economy and increase inflation to help recover lost jobs, Axel said.
Interpretation of the Fed’s message on inflation
The market reacted directly to the Fed’s policy of allowing inflation to now average around its 2% target.
‘The market is struggling with what it does [average inflation targeting] means in practice, “said Axel.” We are going to understand that in the longer term it means higher growth and higher inflation, which means higher interest rates. “
“When the Fed got a little bit of inflationary pressure earlier, the Fed would start tightening it up,” he added. They would pinch off the repairs a little early. ‘
The idea was to prevent periods of recovery and breastfeeding by also reducing the potential for deeper recessions. However, the Fed is now facing an economy that can flourish, and with very high economic growth, inflation can come, Bank of America, Axel said.
Growth in the second quarter is expected to exceed 9%, according to the CNBC / Moody’s Analytics Rapid Update.
Inflation remains low, with the core consumer price index, excluding food and energy, at an annual rate of 1.3% in February. However, inflation levels may start to rise from this month onwards due to the basic effect of last year’s large drop in prices during the economic strike.
The market has challenged the Fed by praising rate hikes for 2023. Meanwhile, the central bank’s collective forecast, called the dot, shows no consensus for a rate hike until 2023.
Treasury inventory management
Tony Crescenzi, portfolio manager and market strategist at Pimco, says the market is also pricing because the treasury will have to spend a lot of stock to pay for fiscal stimulus, given the most recent $ 1.9 billion package and previous pandemic programs.
“A lot of the events in the pricing of the supply of the treasury and the ability of market participants to absorb the supply, and this fear of inflation,” he said. ‘Part of it can be a hoax, but no one really knows, so market participants have to give up on the possibility that inflation could accelerate further than expected. ‘
The market’s expectations are that inflation will average around 2.30% over the next ten years.
“As long as the general financial conditions are conducive to strengthening economic activity, the Fed need not worry about the rise in interest rates so far,” Crescenzi said.
Stock market volatility as yields rise
So far, the stock market has responded to the rate hike with turbulent up and down movements. On Thursday, shares were lower after Wednesday’s rally, and the technological Nasdaq Composite was hit particularly hard.
‘I would not be shocked if we had a bigger downside in the stock market [10-year yield] goes up to 2% quickly, ”said James Paulsen, chief investment strategist at The Leuthold Group.
He said the stock market would be concerned if the pace of interest rate movement remained rapid, but if it was gradually able to adjust to the rises, it would not be a problem.
“If you’re going to have a year where rates rise, it could not be a better year,” Paulsen said, adding that economic growth could be 8%. “I think it’s been a pretty good year for this to happen to the economy and the stock market. Their vulnerability is not nearly as great as it could be further.”
Paulsen expects the 10-year return to reach 2% by year-end.
Crescenzi said because the 10-year yield level is based in part on inflation expectations, he had to adjust to the Fed’s use of the average target range instead of a set target.
“By indicating that it will slow its rate hike until inflation rises and jobs return to maximum employment, the anchor for inflation expectations is not so strong,” he said, “that is what the inflation component in the rise in yields is. unleashed, to some extent. “
Crescenzi said the deafness of the Fed on Wednesday could be a sign of a new view of the central bank.
“It seems that the Fed is taking a more holistic view of financial conditions, as Powell pointed out by mentioning the financial conditions as a whole, rather than utilizing the returns on their own,” he said.