Federal Reserve Chairman Jerome Powell said during the Senate Committee on Banking, Housing and Urban Affairs hearing that he is examining the CARES Bill’s quarterly report to Congress on Sept. 24, 2020, in Washington, DC.
Drew Angerer | AFP | Getty Images
Treasury yields soared on Thursday as bond market players clashed with the Federal Reserve’s willingness to allow inflation to warm.
The ten-year Treasury yield rose from 1.64% on Wednesday late to 1.75% on Thursday, a 14-month high. It stood at 1.706% in the afternoon trading.
The rise in yields, which move against the price, comes a day after Fed Chairman Jerome Powell assured the market that the central bank is not ready to recoup bond purchases and other support measures.
While bond market professionals say there has been no development that has triggered a rise in yields on Thursday, the market’s focus seems to have been on the fact that the Fed plans to leave inflation hot.
“I think this is the bond market that agrees with the fact that inflation could be happening and that it could come because the Fed assures us that they can live with inflation,” said Sonal Desai, investment director at fixed income group Franklin Templeton told CNBC.
A steeper performance curve
The accumulation of interest rates, for the time being, does not pose any risk to the economy. Strategists say yields are still relatively low, mostly because of expectations of explosive economic growth this year.
However, the variation in overnight returns was especially large, even taking into account the recent ten-year increase in performance, which stood at 1.07% six weeks ago. The reference 10 years are widely seen as they influence mortgage rates and other consumer and business loans.
The bond market barely moved on Wednesday afternoon, after the Fed issued its 14-hour ET statement and after Powell reported to the media.
Desai noted that the effect of the market reaction will be a more pronounced yield curve, which simply means a larger difference between yields of different maturities, such as 2-year Treasury bills versus 10-year.
A steeper curve is often seen as a positive sign of growth, while a flattening curve can be a warning.
Ralph Axel, a U.S. rate strategist at Bank of America, said the market responded Wednesday to part of the Fed statement, which sent a mixed message.
“The first message that surprised people was that‘ we don’t believe in walks in 2023, ’” he said. “I think that’s where the initial focus was and I think that kept reducing the initial reaction.”
The second message was that the Fed would keep rates low, let the economy collapse and allow inflation to rise, to help recover lost jobs, Axel said.
Interpret the Fed’s message about inflation
The market responded directly to the Fed’s policy of allowing inflation to now run in an average range around its 2% target.
“The market is facing what it is doing [average inflation targeting] it means 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 a smell of inflationary pressure, the Fed would start taking that away,” he added. They would cut recoveries a little early. “
The idea was to prevent periods of booms and busts, also cutting the potential for deeper recessions. However, now the Fed is facing an economy that can grow and with very high economic growth could cause inflation, said Axel of Bank of America.
According to the quick update from CNBC / Moody’s Analytics, second quarter growth will be over 9%.
Inflation remains low, with the basic consumer price index, excluding food and energy, at an annual rate of 1.3% in February. However, from this month onwards inflation levels could rise due to the basic effect of last year’s sharp fall in prices during the economic close.
The market has been challenging the Fed in setting interest rate hikes for 2023. Meanwhile, the central bank’s collective forecast, called the points plot, 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 in the fact that the Treasury will have to issue a lot of supply to pay the fiscal stimulus, given the latest package of 1.9 trillion of dollars and previous pandemic programs.
“Much of what has happened in the pricing of Treasury supply and the ability of market participants to absorb that supply, and that fear of inflation,” he said. “Part of it could be a counterfeit of the head, but no one really knows, so market participants must anticipate the possibility that inflation may accelerate beyond what was expected.”
Market expectations are averaging inflation at around 2.30% over the next 10 years.
“As long as general financial conditions continue to lead to a strengthening of economic activity, the Fed should not worry about rising interest rates to this point,” Crescenzi said.
Choppiness in the stock market as yields increase
So far, the stock market has reacted to the rate hike with turbulent upward and downward movements. On Thursday, stocks were lower after Wednesday’s rally and the Nasdaq Composite, which has been highly technological, was particularly hard hit.
“I wouldn’t be surprised if we had a bigger setback in the stock market if that were the case [10-year yield] it goes up to 2% quickly, ”said James Paulsen, chief investment strategist at The Leuthold Group.
He said the stock market would be worried if the pace of the interest rate stays fast, but if it would be able to gradually adjust to the increases, it would not be a problem.
“If you have a year where rates are going up, it couldn’t be a better year,” said Paulsen, who noted that economic growth could be 8%. “I think it’s a pretty good year for this to happen in the economy and the stock market. Its vulnerability isn’t as big as it could be later.”
Paulsen expects the ten-year yield to reach 2% by the end of the year.
Crescenzi said that since the ten-year yield level is based in part on inflation expectations, it has had to adjust to the Fed’s use of the average target range, rather than a target. fixed.
“By indicating that it will delay the rise in its rate until inflation recovers and employment returns to peak employment, the anchoring of inflation expectations is not as strong,” he said, “This is the which allows the inflation component to be triggered by rising yields, up to a point ”.
Crescenzi said the Fed’s smooth running on Wednesday could be a sign of a new vision for the central bank.
“It seems to suggest that the Fed takes a more comprehensive view of financial conditions, as Powell pointed out citing financial conditions in general, rather than perfecting returns on their own,” he said.