Fed Rate Decision Sends U.S. Treasury Yields in Different Directions
Shorter-term Treasury yields ticked higher while longer-term yields fell Wednesday after the Federal Reserve signaled interest rates will likely climb more this year than many investors had expected.
In a volatile hour of trading, Treasury yields–which rise when bond prices fall–initially climbed broadly after the Fed released its interest-rate forecast. They then fell as Fed Chairman
Jerome Powell
delivered a more nuanced view of the outlook for interest rates and the economy, emphasizing the Fed’s commitment to fighting inflation but also noting that the pace of future rate increases would depend on incoming economic data.
The Fed’s overall message still caused investors to increase their forecasts for interest rates over the near term and downgrade them over the longer term, since higher rates could lead to a sharper economic downturn.
Investors and economists pay close attention to Treasury yields because they set a floor on borrowing costs across the economy and set a benchmark forward-looking return against which other assets are measured. This year’s climb has helped lift 30-year fixed mortgage rates above 6% for the first time since 2008 and has punished stocks by decreasing the value of companies’ expected earnings.
Investors had widely expected the Fed’s Wednesday decision to raise its benchmark federal-funds rate by 0.75 percentage point for the third consecutive meeting. Investors were more surprised by the central bank’s interest-rate projections, which showed that the median official expected rates to rise to around 4.4% by the end of the year.
That was a big increase from the 3.4% forecast in June and about 0.25 percentage-point higher than many investors were anticipating—leading to an immediate jump in short-term yields.
“There was a whole host of hawkish news heading into this and the Fed came out even more hawkish than the market,” said
Zach Griffiths,
a senior strategist at the research firm CreditSights, referring specifically to the Fed’s interest-rate projections.
At its 3 p.m. settlement—when Mr. Powell was still speaking—the yield on the benchmark 10-year note was 3.511%, according to Tradeweb. That was down from 3.571% Tuesday, its highest close since March 2011.
The yield on the two-year note, which is more sensitive to the near-term interest-rate outlook, settled at 3.993%. That was down from more than 4.1% in the initial minutes after the Fed’s decision, but still up from 3.962% Tuesday, its highest close since 2007. The yield also climbed back above 4% in after-hours trading, flirting with a level that would mark another landmark in this year’s relentless bond selloff.
Some investors and analysts cautioned that it could take more time before investors reached a firm conclusion about the Fed’s actions on Wednesday.
Randy Parrish,
head of public credit at Voya Investment Management, said he struggled to understand exactly why yields fell sharply when Mr. Powell spoke, adding that the chairman’s remarks were broadly consistent with the central bank’s general message about the need to further tighten monetary policy.
“I think ultimately the correct read is, yes, [the Fed] is hawkish; yes, they’re going to keep going, and the risk of ultimately breaking something has probably gone up,” Mr. Parrish said.
Earlier Wednesday, yields had slipped after Russian President
had escalated the war in Ukraine by ordering the mobilization of reserve forces and hinting at Russia’s nuclear-weapons capabilities.
The decline, though, was modest, and the Fed’s looming interest-rate decision quickly took over investors’ attention.
Stubbornly high inflation and expectations for higher interest rates have been a driving force pushing bond yields higher all year. The 10-year yield has climbed from just under 1.5% at the end of 2021 and around 2.6% at the start of August.
Yields fell in early summer as investors became increasingly concerned that the U.S. was already in or entering a recession. They have rebounded since as those worries receded, and Fed officials emphasized that their overwhelming priority was fighting inflation, even if it meant some pain for the economy.
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Two types of economic data have most spooked investors. One is a variety of measures showing rapidly rising wages, which many believe to be the most important contributor to inflation over the longer term. The other is inflation data itself, with last week’s consumer-price-index report showing another big jump in so-called core prices that exclude volatile food and energy categories.
The result has been a high degree of uncertainty.
“It’s a foregone conclusion that the Fed’s going to continue to hike,” said
Jim Vogel,
interest-rates strategist at FHN Financial. “There is zero conclusion about when the Fed might slow rate hikes or the economy will show any impact from tighter monetary policy.”
Gains in so-called real yields, which are adjusted for expected inflation, have been just as dramatic as the increase in nominal yields.
The yield on the 10-year Treasury inflation-protected security, a proxy for the 10-year real yield, has climbed to around 1.2% in recent days, the highest in more than a decade.
TIPS yields are widely seen as an important gauge of financial conditions since businesses typically account for inflation expectations when determining their cost of borrowing and making investment decisions.
The 10-year TIPS yield was around minus 1% at the start of the year, providing what many economists viewed as a powerful economic stimulus even in the midst of decades-high inflation.
In recent weeks, rising real yields have reflected not just mounting interest-rate expectations but also falling inflation forecasts—a trend that itself is related to the Fed’s aggressive tightening campaign.
Investors’ forecast for annual inflation over the next five years, as measured by the gap between nominal and inflation-protected Treasurys, has recently fallen to around 2.5% from a high of 3.6% in March.
Investors then expect inflation to average around 2.3% in the five years after that, roughly matching the Fed’s 2% annual target.
Write to Sam Goldfarb at sam.goldfarb@wsj.com
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