Benchmark 10-year U.S. Treasury yields surged to levels not seen in 16 years on Thursday, a day after the Federal Reserve delivered a surprise to investors by signaling the potential for an additional rate hike and projecting fewer cuts in the coming year.
As widely anticipated, the U.S. central bank opted to maintain interest rates at their current levels. However, the Fed indicated that there might still be room for one more rate hike this year, potentially pushing the benchmark overnight interest rate into a range between 5.50% and 5.75%.
The Fed also revised its expectations for rate cuts in 2024, now forecasting a half-percentage-point reduction. Back in June, Fed officials had been looking at a full percentage point decrease for the same period.
Will Compernolle, a macro strategist at FHN Financial in New York, observed that this announcement took the markets by surprise. Many had believed that three months of encouraging inflation data would lead the Fed to adopt a more accommodative stance. However, for various reasons, the central bank appears committed to maintaining its hawkish posture.
Fed Chair Jerome Powell, in his remarks on Wednesday, emphasized the strength of the economy and robust job growth. He suggested that the central bank would continue to apply pressure to financial conditions through 2025, with less adverse impact on the economy and labor market compared to previous inflationary periods.
Powell also emphasized the need for “convincing evidence” that the Fed has reached the appropriate interest rate level to achieve its 2% inflation target.
Whether the Fed follows through with its hawkish outlook will largely depend on forthcoming economic data. Traders in Fed funds futures are pricing in only a partial likelihood of another rate hike, with a 32% probability in November and a 45% chance by December, according to the CME Group’s FedWatch Tool.
The surge in benchmark 10-year Treasury note yields resulted in a climb to 4.490%, reaching levels last seen in November 2007. Two-year yields, which are sensitive to interest rate changes, also rose to 5.202%, marking their highest point since July 2006.
The yield curve, which represents the relationship between two-year and 10-year Treasury notes, exhibited an inversion that narrowed to minus 69 basis points.
On the economic front, data released on Thursday showed that the number of Americans filing new claims for unemployment benefits had unexpectedly declined in the previous week. However, this trend may be temporary, as a partial strike by the United Auto Workers (UAW) union is causing automobile manufacturers to temporarily lay off workers due to material shortages. This could potentially lead to an increase in unemployment claims in the coming weeks.
In the realm of government finance, the U.S. Treasury Department announced its intention to sell $15 billion in 10-year Treasury Inflation-Protected Securities (TIPS) on Thursday. These inflation-linked bonds are designed to protect investors from the eroding effects of inflation, making them a valuable component of the Treasury’s debt offerings.
In conclusion, the Federal Reserve’s recent announcement of a potentially higher interest rate trajectory caught the financial markets by surprise, leading to a significant spike in Treasury yields. The central bank’s commitment to maintaining a hawkish stance reflects its determination to address rising inflation and preserve economic stability. However, the Fed’s future actions will be closely linked to economic data, and market participants are eagerly awaiting further developments to gauge the central bank’s intentions.
