U.S. Treasury yields rose after the Fed cut short-term rates
The Federal Reserve is finally cutting interest rates. One key gauge of borrowing costs has been going up anyway.
Yields on longer-term U.S. Treasurys have ticked higher since the Fed approved a 0.5 percentage point rate-cut last week. The yield on the benchmark 10-year U.S. Treasury note, which helps set interest rates on everything from mortgages to corporate bonds, settled Friday at around 3.73%, up from 3.64% the day before the Fed’s move.
The climb is a reminder that the Fed doesn’t have complete control over borrowing costs in the country. The central bank manages short-term rates that banks charge each other for overnight loans, which shift costs on credit-card debt and other types of floating-rate loans.
But rates on a lot more debt are driven primarily by swings in Treasury yields. Those are set by where investors think the Fed’s short-term rates will go in the future, rather than where they are now.
Treasury yields are still about a percentage point lower than they were earlier in the year, when rate cuts seemed more uncertain. But there is no guarantee that they will fall any further if the economy remains stable, potentially frustrating potential home buyers and other borrowers hoping for bigger declines.
John Madziyire, head of Treasurys at Vanguard, said that his team is betting that yields will likely rise a little more, noting that the market is still positioned for rates to go lower than most Fed officials are themselves projecting.
“If they’re not going to be as aggressive as the market is pricing, in that scenario 10-year yields actually go higher,” he said.
The post-Fed climb is particularly notable because of the debate over whether the central bank should have kicked off its rate-cutting campaign by lowering its benchmark federal-funds rate by the traditional 0.25 percentage point or the more aggressive 0.5 point.
Advocates for a larger cut were generally more concerned about the economy. They believed the Fed should take a bolder step to prevent further weakening in the labor market. But the size of the cut might not have mattered that much.
In fact, the choice might have even helped drive yields higher, according to some investors. In opting for the larger reduction, the Fed signaled that it was willing to fight to keep the economy out of a recession, which would almost certainly lead to even bigger cuts.
At the same time, officials signaled they were optimistic about the economy and most likely will cut rates by only a quarter point at future meetings.
A modest uptick in yields won’t necessarily undercut the Fed’s ambitions. Even with its latest move, the 10-year yield is still down from roughly 5% last October and 4.7% as recently as April. Yields fall when bond prices rise.
Interest rates on new fixed-rate mortgages could also come down a little even if Treasury yields don’t. That is because a key component of mortgage rates is the extra differential, or spread, that lenders charge above the 10-year yield—and that has tended to shrink as the Fed has cut rates in the past.
Interest-rate futures suggest that investors think that the Fed’s benchmark rate will drop from near 5% now to just under 3% by the end of next year, according to CME Group. Fed officials, meanwhile, expect that rate to end next year between 3.25% and 3.5%, according to the midpoint of their different forecasts.
Some investors, more pessimistic about the economy, are betting that Treasury yields could fall further from here.
Jamie Patton, co-head of global rates at TCW, said her team’s view is that the 10-year yield could drop below 3% within the next six months as the lingering effects of the Fed’s previous rate increases help to drive the economy into a recession.
“The Fed easing rates yesterday really doesn’t affect the economy today,” she said. “It will help the economy in the future, but over the next four to six months, the economy is still going to feel the lagged effects of tightening.”
The 10-year yield’s direction will also be determined by how much extra compensation investors demand to hold longer-term Treasurys over shorter-term debt. Although this so-called term premium has trended lower in recent decades, many investors think the 10-year note should yield around a percentage point more than short-term rates once those level out.
That is partly because investors are anticipating a large amount of Treasury issuance in the coming years to fund elevated federal budget deficits. Some also cite the risk of inflation rising again.
Inflation has subsided, but it is still above the Fed’s 2% target, “so I think investors on the long end of the market want to be compensated for that,” said Jeff Given, a senior portfolio manager at Manulife Investment Management.
Source: wsj.com
