Bond yields: what you need to know

Since Fed Vice Chairman Richard Clarida spoke last Wednesday, the 10-year Treasury yield has risen by more than 20 basis points, or 0.20 percent. 

Other central bank officials, including Atlanta Fed President Raphael Bostic, have recently expressed support for reducing the central bank’s $120 billion monthly bond-buying program.

Late Tuesday, the 10-year Treasury yield was 1.35 percent.

Lately, the yield has been moving unusually lower due to a variety of factors, some technical in nature and others reflecting concerns about Covid and slowing growth. Now, the 10-year yield is rising in response to Fed speakers and improved economic data. It is also rising ahead of the Treasury auction on Wednesday.

Observations that ‘turned the market’

Clarida is significant because the market views him as a dove at the heart of the Fed, and his comments were direct.

The Fed’s economic goals, according to the vice chairman, could be met by the end of next year, and the central bank could begin raising interest rates in 2023. He also stated that there is a chance that inflation will surprise to the upside, and he reportedly stated that if the economy continues to improve as expected, he may support reducing the Fed’s bond purchases later this year.

Clarida did not provide a timeline for the tapering of the Fed’s $120 billion monthly bond-buying program in his comments last week.

There are two critical tests for the 10-year Treasury yield.

On Wednesday, the 10-year will face two significant tests. First, at 8:30 a.m. ET, the consumer price index will be released, and if it is higher than the half-percentage-point increase expected, yields may continue to rise. There is also a $41 billion 10-year auction at 1 p.m., which could influence the direction of rates depending on demand.

But, for the time being, the Fed is driving the market. 

On Monday, Atlanta Fed President Bostic stated that if the labor market continues to improve, the Fed could begin tapering in the fourth quarter. On the same day, Richmond Fed President Thomas Barkin stated that the economy has made “substantial progress” in terms of price stability. Finally, Boston Fed President Eric Rosengren told the Associated Press on Monday that the Fed will reduce bond purchases this fall and make an announcement in September.

“It appears that Fed speakers are waging a campaign to halt what has been an unending rally toward lower rates,” Goncalves said. “You could say Waller started it… Clarida set the tone last week.”

According to Goncalves, the 10-year yield has also broken above its 200-day moving average, which is currently around 1.29 percent, an important technical level for some investors. The 10-year Treasury yield is the most closely followed because its movements affect the stock market, and it is the rate that influences mortgages and other loans.

Friday’s strong jobs report added fuel to the fire for a rate hike, as the 943,000 new jobs brought the Fed closer to its goal of a stronger labor market. 

The chorus is missing a key voice.

“I would definitely comment that the most senior Fed official has not joined the chorus,” said Michael Schumacher of Wells Fargo Securities. He believes Powell must support winding down the program before the market expects the Fed to proceed.

The bond program was expected to be discussed by central bank officials at a symposium in Jackson Hole, Wyo., beginning Aug. 26. Schumacher stated that he does not expect Powell to agree to tapering by that date. He believes it will take several more jobs reports before Powell joins the chorus, and that his speech in Jackson Hole will remain noncommittal.

“If he says almost nothing, people will be disappointed and he will sound dovish,” Schumacher predicted. He and others noted that it was intriguing that Clarida, who market observers believe is close to Powell, would have sounded as hawkish as he did.

“It is quite unusual for the governors to disagree. “I’m sure Powell and Clarida talk on a regular basis,” Schumacher said.

Goncalves believes the comments are a foreshadowing of the tone that will be set in Jackson Hole. “If the Fed speakers were just silent between now and Jackson Hole and rates were at the lows, at 1.1 percent, 1.12 percent, and then they shocked us, we would have a ‘taper tantrum’ in the last week of August,” he said, referring to the negative market reaction when the Fed abandoned easy policy in 2013. “They want to avoid that, and they want to be ahead of the game.”

The move in Treasurys comes as the market is abuzz with speculation about whether Powell will remain Fed chairman after his term expires in February. According to the Wall Street Journal, Powell’s opposition from progressive Democrats has made it unclear whether he will remain chair.

National Alliance’s Andy Brenner believes Powell is not yet in favor of tapering. “The Federal Reserve is becoming more hawkish. There is no doubt about it. It’s just a matter of time before Powell gets the message,” he said.

According to Brenner, the market trend is now toward higher yields. He believes the 1.36 percent level is significant, and it appears on charts ahead of two moves higher. He also stated that a Fed taper in the fall would be appropriate because the Treasury is expected to reduce the size of auctions due to higher tax revenues.

“At the end of the day,” said Schumacher, “the market will take its cues from the Fed, not the data.”

He claims that the Fed has aided in pushing yields higher, and that market movements are more visible. “It was unclear why the yield fell to 1.12 percent… “The rise was a little more obvious than the drop,” he explained.

According to Schumacher, the Fed will announce tapering between October and December of this year. He expects the Fed to begin slowing its $80 billion in Treasury purchases and $40 billion in mortgage purchases early in the new year.