Treasury yields fell Wednesday afternoon after the most recent update on monetary policy from the Federal Reserve showed few signs that the central bank would ratchet up its pace of rate increases, even as the Fed conceded that the outlook for inflation had strengthened.
Wall Street traders also were watching the narrowing spread between the 2-year and 10-year Treasury note, which is often looked at as a gauge of investors’ dimming outlook for the economy, but that is also a typical feature of a rising-rate environment.
How are Treasurys performing?
The 2-year note yield sensitive to shifting expectations for monetary policy, was down 1.6 basis points to 2.495%. The 10-year Treasury note yield fell 1.1 basis points to 2.964%, while the 30-year bond yield was mostly flat 3.134%, according to WSJ Market Data Group.
Bond prices move in the opposite direction of yields. One basis point is one hundredth of a percentage point.
The gap between the 2-year and 10-year Treasury, referred to as the yield curve, was at 46.9 basis points early Wednesday.
Concerns that the so-called yield curve could eventually invert, with short-dated yields moving above long-dated yields, is keeping investors on edge. An inverted yield curve has often preceded a recession.
What’s driving the market?
As expected, the Federal Reserve didn’t announce an increase to its benchmark interest rate in its statement, keeping the fed-funds rate between a range of 1.50% to 1.75%. Investors, however, keyed in on language suggesting the central bank’s outlook on inflation had increased and that it would run closer to the Fed’s 2% target over the next 12 months.
Some suggested the repetition of the phrase that the inflation target was “symmetric” gave the policy statement a dovish tone. Economists said this could indicate the central bank may be willing to allow inflation slightly overshoot 2%, without sparking some form of policy response such as an accelerated pace of rate hikes.
The Fed’s preferred inflation gauge, the personal-consumption expenditure price index, rose to a 12-month rate of 2%, hitting its annual target for the first time in a year and raising concerns that policy makers may be forced to increase rates at a faster clip than the two or three additional increases anticipated in 2018 to tamp down runaway price climbs. Rising inflation is bad for bonds because it chips away at its fixed payments, while higher rates undercut demand for existing government debt, pushing yields up, as market participants anticipate richer yielding debt in the future.
Also check out: PCE could be prelude to faster rise in U.S. interest rates
The Fed, now run by Chairman Jerome Powell, also said that monetary policy remain accommodative for now and that risks were roughly balanced.
The policy-setting Federal Open Market Committee lifted fed-funds futures rates in March and targeted two more hikes this year. The market is now on board and is pushing yields higher. Many investors think the Fed will ultimately move rates up three more times this year. The market has priced in over 40% chance of such an outcome.
U.S. government bond rates also have climbed as investors have expected greater issuance amid an expanding federal budget deficit.
On Wednesday, the Treasury Department announced increases to auctions across the bond market. It said it would issue a net $75 billion of debt, $101 billion than their previous forecast. This comes after the report that the government had borrowed on net $488 billion, a record for any such period.
Meanwhile, global trade discussions, which could also become a factor for rising prices, were in focus as a delegation, including Treasury Secretary Steven Mnuchin and Trade Representative Robert Lighthizer, was set to go to Beijing to discuss softening trade tensions between China and the U.S.
Bond investors have feared that talk of tariffs and tit-for-tat moves between the world’s largest economies could disrupt the market and put pressure on Treasurys because Beijing is a big holder of U.S. paper. However, at the Milken Institute’s annual conference on Tuesday, Mnuchin emphasized that he wasn't worried about China selling U.S. debt as retaliation in a trade war, adding that the U.S. had plenty of buyers for its government paper.
What are strategists saying
“The ensuing rally in [Treasurys] is likely due to the passage of event risk and the market setting up for a hawkish Fed rather than anything materially dovish or hawkish from the statement itself,” said Aaron Kohli, fixed-income strategist at BMO Capital Markets.
“We expect to see greater Treasury issuance across the curve beginning in the second half of the year to service much larger budget deficits,” said strategists at Wells Fargo Securities.
Which data are in focus?
ADP’s April release on private-sector employment showed a monthly gain of 204,000 jobs, compared with economists’ consensus expectations for 200,000 and a gain of 241,000 in March, according to FactSet data. The more closely watched nonfarm-payrolls report is due Friday, with expectations for unemployment to fall to 4% from 4.1% and a gain of 188,000 workers in April.