Stock-market moves show bond traders are still in charge as yields renew rise

Stock-market moves show bond traders are still in charge as yields renew rise

Rising Treasury yields may not be doing as much ‘heavy lifting’ as Fed thinks, strategist says

The roughly $25 trillion Treasury sector remained in firm control of much of the financial market on Thursday as long-dated yields headed toward 5% again, taking the steam out of equities and helping the greenback recoup this week’s earlier losses.

Investors resumed a selloff of government debt that’s sent 10- and 30-year yields to some of their highest levels in 16 years, with each posting their biggest one-day jumps in more than a week to end the New York session at 4.71% and 4.87%, respectively. Thursday’s moves broke a two-day rally seen through Wednesday, which had sent both rates to their lowest closing levels of this month as traders focused on a possible end to Federal Reserve rate hikes.

September’s hotter-than-expected headline inflation figures from the consumer-price index, released on Thursday, boosted the market-implied likelihood that the Fed would need to hike in December. The data also cast doubt on policy makers’ view that they could rely on a recent runup in long-dated yields to do some of the heavy lifting for them and to tighten financial conditions without the need for another rate hike, analysts said.

“The bond market is still king,” Marc Chandler, chief market strategist at Bannockburn Global Forex in New York, said via phone on Thursday. The post-CPI broad-based selloff in Treasurys “is helping the dollar recoup some losses seen earlier this week and weighing on the stock market after a four-day rally.”

While it’s too soon to tell how higher longer-term rates will likely impact Fed policy, one thing is clear, Chandler said. The market moves seen on Thursday in response to September’s CPI inflation data appear to be undercutting the Fed’s main arguments for avoiding another rate hike, he said.

One of the biggest questions for policy makers has been precisely how much of the recent aggressive rise in yields is based on U.S. economic strength or some other unquantifiable factor. On Monday, Dallas Fed President Lorie Logan said that the Fed “may need to do more” to the extent that economic strength is the reason behind the recent rise in yields. If the rise is instead being driven by higher term premiums, she said, “there may be less need to raise the fed funds rate.” Term premium refers to the compensation that investors demand for the risk of holding a bond over the life of that security.

Since the Fed’s Sept. 20 policy decision, which reiterated a higher-for-longer theme in interest rates, 10- BX:TMUBMUSD10Y and 30-year Treasury yields BX:TMUBMUSD30Y respectively jumped by 43.7 basis points and 54.3 basis points through last Friday. Then, with the bond market closed on Monday for Columbus Day and Indigenous Peoples Day, both rates dived by a total of around 20 basis points each on Tuesday and Wednesday, before turning higher once again on Thursday.

According to Bannockburn’s Chandler, Thursday’s Treasury-market moves are being driven more by “what seems to be inflation and the strength of the economy, rather than term premium, which means the market may not have done some of the heavy lifting that some Fed officials have been suggesting.”

“We are not done testing a 5% yield on the 10-year note or 30-year bond,” particularly now that both rates have finished higher during the New York session, Chandler said. He described the greater demand seen on Tuesday and Wednesday for 10- and 30-year government debt — which sent their prices higher following the outbreak of war in the Middle East — as “a dead cat bounce” that’s proving to be temporary and short-lived in nature.

As of Thursday, 6-month through 30-year Treasury yields were all broadly higher, with 10- and 30-year yields reversing all of their declines seen on Wednesday.

All three major U.S. stock indexes DJIA SPX COMP finished lower, while the ICE U.S. Dollar Index DXY climbed 0.7% on its way to erasing most of its losses this week. The dollar moves according to where investors see U.S. interest rates going relative to other countries, while stocks tend to get hit as traders factor in a higher cost of doing business by companies and less attractive returns relative to government debt.

Meanwhile, fed funds futures traders priced in a 31.4% chance of a quarter-point Fed rate hike in December, which would lift the main interest-rate target to between 5.5%-5.75%. They also saw a 32.1% likelihood of such a move by January. That helped send the policy-sensitive 2-year rate BX:TMUBMUSD02Y to an intraday high of 5.08% in New York trading.

Minutes of the Fed’s Sept. 19-20 meeting, released on Wednesday, showed that most policy makers judged that one more rate increase would likely be appropriate at a future meeting, even though they saw a need to proceed carefully.

Also on Wednesday, Fed Gov. Christopher Waller said that the recent run-up in Treasury yields has been doing some of the Federal Reserve’s job of slowing the economy down. Fed Vice Chair Philip Jefferson said earlier this week that he is watching the increase in Treasury yields as a potential additional restraint on the economy.

Policy makers have been “pointing to increases in yields at the long end of the curve as having done some of their tightening work for them, reducing the need for additional hikes. Today’s data turns that message on its head,” said economist Thomas Simons of Jefferies JEF, -2.72%.

In a note, Simons said that “we are not sure if there is enough time for the Fed to re-pivot before the next FOMC meeting on Nov. 1, but this certainly increases the risk that Powell supercharges his hawkish rhetoric at the press conference, and increases market expectations for a rate hike in December.”

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