Short-term Treasury rate hike could come in ‘direct conflict’ with dovish Fed policy, broker warns

Will the Federal Reserve step up this time around?

This has been a key question over the past few days among investors swimming in the ocean of US government debt, after Federal Reserve Chairman Jerome Powell brushed off concerns about rising long-term Treasury yields. term, in two days of testimony on Capitol Hill.

But the fast-moving action this week in the bond market now suggests some traders have begun to attack the central bank on its own turf – shorter-dated Treasuries – and raise the specter. of a potentially messy standoff with the Fed, after an acceleration in the bond market sell-off.

“This is in direct conflict with what the Fed says versus what it wants,” Steve Feiss, fixed income director at Etico Partners, said in emailed comments.

Even so, analysts concede that the Fed may be willing to let long-term rates rise, a sign senior officials believe economic fundamentals are improving.

Ed Al-Hussainy, senior interest rate and currency analyst at Columbia Threadneedle Investment, suggested that the only catalyst likely to force the Fed’s hand to change its accommodative monetary policy would be a crack in credit markets.

Despite the turmoil in the Treasury market, the most liquid parts of the roughly $10.5 trillion corporate debt markets – exchange-traded funds – were under some selling pressure, but less than Dow Jones Industrial Average
drop of nearly 1.5% in afternoon trade and S&P 500 Index
down 2.1%.

Corporate bond market stands at $45 billion iShares iBoxx $ Investment Grade Corporate Bond ETF
was down 1.7%, while the key $9.3 billion high-yield or junk-bond market SPDR Bloomberg Barclays High Yield Bond ETF
was 0.7% lower.

Nonetheless, it should be noted that yields on shorter-term paper have risen, an area in which the central bank generally seeks to exert more control through its policy measures.

See: Has Powell lost control of yields or is the latest hike part of the Fed’s playbook?

High short-term yields could mean markets expect the central bank to raise rates much sooner than the extended plan it has announced.

Powell said again this week that there were no plans to limit his $120 billion-a-month bond-buying program or raise benchmark interest rates, which help businesses and financial markets to access liquidity during the pandemic.

But the yield of 5-year treasury bills TMUBMUSD05Y,
climbed 13.6 basis points to 0.762% on Thursday. The rate of 10-year notes TMUBMUSD10Y,
jumped 8.9 basis points to 1.478%. Bond prices move in the opposite direction of yields.

Investors have been watching the 5-year note’s moves as it roughly straddles the expected timeline for the central bank to implement its series of rate hikes after pushing them back into a range of 0% to 0.25% at the start of the pandemic.

But Feiss at Etico Partners said even the recent spike in short-term rates may not be enough to prompt the Fed to act, especially as trading in the eurodollar market suggests that most upside expectations rates were postponed until 2023 and 2024, which is when the central bank was expecting its first rate hike.

The Fed’s dot chart, which helps inform the central bank’s rate-setting committee as it forecasts the direction of benchmark interest rates, showed that the central bank would start raising rates in 2024. .

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