Federal Reserve Chairman Jerome Powell testified during a Senate hearing on the Senate Banking, Housing and Urban Affairs Committee, examining the CARES Act’s quarterly report to Congress on September 24, 2020, in Washington, DC.
Drew Angerer | AFP | Getty Images
Treasury yields exploded on Thursday as bond market players faced the Federal Reserve’s willingness to allow inflation to warm.
The 10-year Treasury yield rose from 1.64% late Wednesday to 1.75% on Thursday, a 14-month high. It was at 1.706% in the afternoon trading.
The rise in yields – which run counter to the price – comes a day after Fed Chairman Jerome Powell assured the market that the central bank is not ready to restore bond purchases and other support measures.
While bond market professionals say there has been no development that triggered rising yields on Thursday, the market’s focus seems to have been on the fact that the Fed intends to let inflation ignite.
“I think this is the bond market that reconciles with the fact that inflation could and could happen because the Fed assures us that I can live with inflation,” said Sonal Desai, chief investment officer at Franklin Templeton Fixed Income. Group, CNBC said.
A steeper yield curve
The advance of interest rates, for the time being, does not present a risk for the economy. Strategists say yields are still relatively low, especially given expectations for explosive economic growth this year.
However, the overnight yield movement was particularly high, even given the recent 10-year yield increase, which was 1.07% six weeks ago. The 10-year benchmark is widely viewed as it influences mortgage rates and other consumer and business loans.
The bond market barely moved on Wednesday afternoon, after the Fed issued the 14:00 ET statement and after Powell informed the media.
Desai mentioned that the effect of the market reaction will be a steeper yield curve, which simply means a bigger difference between yields with different maturities, such as 2-year government bonds compared to 10-year ones.
A steeper curve is often seen as a positive sign for growth, while a flattening curve can be a warning.
Ralph Axel, an American strategist in the field of tariffs at Bank of America, said that the market responded on Wednesday to part of the Fed’s statement, which sent a mixed message.
“The first message that surprised people is that ‘we don’t believe in hiking in 2023,'” he said. “I think that’s where the initial focus was, and I think that kept the initial reaction from dampening.”
The second message was that the Fed will keep rates low, let the economy warm up and allow inflation to rise, to help recover lost jobs, Axel said.
Interpretation of the Fed’s message on inflation
The market responded directly to the Fed’s policy of allowing inflation to now run in the medium range around its 2% target.
“The market is struggling with what it does [average inflation targeting] in practice, Axel said. “We understand that it means higher growth and higher inflation in the long run, which means higher interest rates.”
“When the Fed used to get inflationary pressure, the Fed would start tightening in that direction,” he added. They will stop recovering a little earlier. “
The idea was to prevent periods of explosions and busts, also cutting the potential for deeper recessions. However, the Fed is now facing an economy that could grow and very high economic growth could come inflation, Bank of America’s Axel said.
The increase in the second quarter is expected to be over 9%, according to CNBC / Moody’s Analytics Rapid Update.
Inflation is still low, with the core consumer price index excluding food and energy at an annual rate of 1.3% in February. However, starting this month, the level of inflation could rise due to the base effect of last year’s sharp fall in prices during the economic close.
The market challenged the Fed by setting rates to raise the rate for 2023. Meanwhile, the central bank’s collective forecast, called the chart, shows no consensus for a rate hike until 2023.
Treasury supply management
Tony Crescenzi, portfolio manager and market strategist at Pimco, said the market is also priced because the Treasury will have to issue a lot of supply to pay the tax incentive, given the latest packages of 1 , $ 9 trillion and previous pandemic programs.
“A lot of what happened in the pricing of the Treasury offer and the ability of market participants to absorb that offer and this fear of inflation,” he said. “Some of it could be a fake, but no one really knows, so market participants need to appreciate the possibility that inflation will accelerate beyond what is expected.”
Market expectations are that inflation will average around 2.30% over the next 10 years.
“As long as general financial conditions remain favorable for a strengthening of economic activity, then the Fed should not worry about rising interest rates so far,” Crescenzi said.
The size of the stock markets as yields increase
So far, the stock market has reacted to the rate hike with turbulent up and down movements. On Thursday, shares were lower after Wednesday’s rally, and the Nasdaq Composite, which was very strong, was particularly hard hit.
“I would not be shocked if we had a greater withdrawal from the stock market if that were the case [10-year yield] going 2% fast, “said James Paulsen, chief investment strategist at The Leuthold Group.
He said the stock market would be worried if the pace of interest rate movements remains fast, but if it is able to adapt to gradual growth, it would not be a problem.
“If you have a year in which rates go up, it couldn’t be a better year,” Paulsen said, noting that growth could be 8 percent. “I think it’s a good enough year for this to happen to the economy and the stock market. Their vulnerability isn’t nearly as great as it could be on the road.”
Paulsen expects the 10-year yield to reach 2% by the end of the year.
Crescenzi said that since the 10-year yield level was partly based on inflation expectations, it had to adjust to the Fed’s use of the average target range, rather than a set target.
“By indicating that it will delay the rate hike until inflation rises and employment returns to maximum employment, the anchor for inflation expectations is not as strong,” he said. up to a point.”
Crescenzi said Fed evidence on Wednesday could be a sign of a new vision from the central bank.
“It seems to suggest that the Fed is taking a more holistic view of financial conditions, as Powell pointed out, citing financial conditions as a whole, rather than improving its yields on its own,” he said.