The Treasury market continues to price in firmer odds of another rate hike by the end of the year. Notably, the policy sensitive 2-year yield edged up to 1.60% yesterday (Oct. 24) for the first time since 2008, signaling that a hawkish bias continues to dominate fixed-income trading.
The benchmark 10-year yield advanced too, although this rate’s upward bias remains well below its peak in recent years. The 10-year rate inched up to 2.42% on Tuesday, a five-month high, based on daily data via Treasury.gov.
DoubleLine Capital Chief Investment Officer Jeffrey Gundlach, an influential voice in the bond market, tweeted on Tuesday that “The moment of truth has arrived for secular bond bull market!”
Meanwhile, Fed funds futures are estimating a 97% probability that the Federal Reserve will lift its current 1.0%-to-1.25% target rate at the December FOMC meeting, based on CME data this morning.
Growing speculation that President Trump is considering replacing Fed Chair Janet Yellen with Fed Governor Jerome Powell or Stanford economist John Taylor is also part of the mix for the bond market lately. Taylor’s considered a hawkish choice, based on his work for developing a set of rules for the central bank’s interest-rate decisions. According to CNBC, the so-called Taylor Rule indicates that Fed funds should be significantly higher at roughly 3%, more than double the current 1.0%-to-1.25% target range.
Another factor lifting rates lately: strengthening expectations that Congress will pass tax-reform legislation, including the prospect for a cut in tax rates that’s considered a pro-growth measure by the administration. “It’s going to be all growth,” Trump recently asserted. “That growth can be staggering.” Many analysts are skeptical, but for now, the bond market’s inclined to assume that a tax cut will be a positive for the economy.
Despite the recent rise in yields, the Treasury market’s implied inflation forecast remains relatively subdued and steady. The yield spread for the nominal 5-year rate less its inflation-indexed counterpart, for instance, is currently 1.73% — roughly the average for the range so far in 2017 and moderately below the Fed’s 2.0% inflation target. The implication: there’s still a case to forgo more rate hikes in the near term.
