Treasury yields bounce after Fed keeps rates unchanged

U.S. Treasury yields climbed across the board Wednesday after the Federal Reserve stayed the course with its monetary policy plan and emphasized the strength of the domestic economy, affirming expectations that a further two rate increases are in store in 2018.

“Economic activity has been rising at a strong rate,” read the policy-making Federal Open Market Committee statement, which was released after a two-day gathering of its members led by Jerome Powell.

The 10-year U.S. government bond yield TMUBMUSD10Y, +1.41% rose 3.7 basis points to 3.001%, hitting a psychologically significant level it hasn’t seen since May 23, according to Dow Jones Market Data.

The two-year note yield TMUBMUSD02Y, +0.00% the most sensitive to monetary policy moves, inched 1.2 basis points higher to 2.682%. The 30-year bond yield TMUBMUSD30Y, +1.68% known as the long bond, added 4.1 basis points to 3.126%.

The initial reaction to the Fed statement was muted but yields pushed higher in Wednesday afternoon trade as investors focused on the central bank’s outlook.

“There were very few changes in this policy statement, both in the tone and content,” said Ward McCarthy, chief financial economist at Jefferies. He said the FOMC continued to reflect “optimism about the economy,” adding that he saw the probability of rate hikes in September and December in play, with the expectation that the central bank may signal that it is approaching the so-called neutral rate, a level that will neither hinder nor boost economic expansion.

The FOMC voted unanimously to hold rates at a range between 1.75% and 2%, after raising rates in June.

The market is placing a nearly 90% probability of rate increase in September, according to CME Group data after the statement.

The widely-expected Fed decision follows the release of the second-quarter gross domestic product that showed the U.S. economy expanded at a 4.1% rate, the strongest annualized rate in nearly four years.

In the Asian hours, U.S. yields initially took their cues from Japanese 10-year note TMBMKJP-10Y, +163.97% which surged to 0.126% from 0.044% late Tuesday in New York, marking the biggest yield jump in 2 years, a day after the biggest yield drop in the same period. Bond prices and yields move inversely.

The moves in Japanese government bonds or JGBs may have been exacerbated by the unwind of bearish bets, according to Bloomberg.

“Most of the selling took place in the long-end of JGBs (10yr up 6.3bps) on reports of a large margin call in JGB futures,” wrote Tom di Galoma, managing director of Treasurys trading at Seaport Global Securities in a Wednesday research note.

That selloff in Japanese paper came a day after Bank of Japan Gov. Haruhiko Kuroda vowed to maintain longstanding dovish strategies, albeit with tweaks, including incorporating forward guidance for the first time, with an emphasis that it intends to maintain rates at ultralow levels for an “extended period of time.” The BOJ also said in its yield-curve policy that it would allow for a rise to a range as wide as 0.2%, compared with a range between negative 0.1% and 0.1%, in a nod to criticism that the bank’s efforts to maintain superlow levels were taxing the central bank and weren’t sustainable. That new policy move may have been put to the test.

“I do think [the selling in bonds] has to do with what’s going on in Japan,” said Donald Ellenberger, senior portfolio manager at Federated Investors.

Yields for U.S. government paper also received a further push higher before the FOMC update as the Treasury Department announced it would sell $78 billion in notes and bonds next week at its quarterly refunding operations, which is $5 billion larger than the package announced last quarter.

Increased supplies of Treasurys can weigh on bonds, pushing prices lower and yields higher.

Beyond the Fed policy update and Treasury announcement, investors watched a string of economic reports, as the latest data on private-sector employment showed 219,000 jobs added in July, well above the 178,000 that had been expected.

Separately, the Markit manufacturing purchasing managers index came in at 55.3 in July. The Institute for Supply Management’s July manufacturing index was 58.1%, below expectations for a reading of 59.5%. A reading of at least 50 indicates improving conditions.

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