Overnight, 10Y Treasury yields jumped to 1.56% after Federal Reserve Chairman Powell showed little concern yet about this year’s surge in yields.
In a Wall Street Journal webinar, Powell only said the recent sharp rise in yields ‘was notable and caught my attention. I would be concerned by disorderly conditions in markets or persistent tightening in financial conditions that threatens the achievement of our goals.’ Powell did not signal the Fed was ready to take any action yet to counter the surge in yields, prompting Treasury rates and the USD to jump.
This year’s bond market sell-off is being driven by rising inflation expectations and US growth prospects. This week we increased our 12-month forecast for 10Y Treasury yields from 1.50% to 1.90%. 10Y yields began the year at 0.90%.
So far Fed officials do not see this year’s surge in Treasury yields putting the central bank’s longterm goals of securing full employment after the pandemic and stable 2% inflation at risk.
In the next few months, however, policymakers are unlikely to remain indifferent if 10Y Treasury yields keep surging towards 2.00% and sharply weaken risk assets.
Currently, Treasury yields are still low by historic standards. But Fed policymakers will not want to see 10Y yields keep rising by 30-40ps each month as already occurred in February.
Source: Bank of Singapore, Bloomberg
Tighter financial conditions would hurt equities, push inflation expectations back below the Fed’s 2% inflation target and increase real yields to the detriment of the recovery.
Notably, the Fed continues to be very dovish about the overall economic outlook. Powell again signalled officials were not ready to start tapering quantitative easing: ’we will be patient. We’re still a long way from our goals.’
Powell also sees rises in inflation this year as the economy re-opens as being only temporary ‘and certainly not staying up to the point where they would move inflation expectations materially above 2%.’ He therefore gave no indication the central bank will consider raising its fed funds interest rate from 0.00-0.25% if inflation exceeds its 2% target in 2021. Instead the Fed continues to forecast no interest rate rises until 2024 as it expects inflation to fall back again below its 2% goal in 2022 and 2023.
Thus, given the central bank’s very dovish economic outlook, we expect the Fed will become concerned if US Treasury yields were to keep surging higher over the next few months and cause further sharp sell-offs in risk assets.
Powell said: ‘financial conditions are highly accommodative and that’s appropriate given the ground the economy has to cover.’ But he also warned: ‘if conditions do change materially, the committee is prepared to use the tools that is has to foster the achievement of its goals.’Disclaimer applicable to recommendation
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