The yield on US 10-year Treasury has hit 3.5% for the first time since 2011 as markets brace for aggressive Fed tightening in the coming months.
The Fed meeting is set to begin tomorrow and on Wednesday the US central bank would announce its rate hike decision. The Fed has raised rates four times this year including two 75-basis point hikes in June and July.
The 10-year Treasury yield almost hit 3.5% before the June FOMC meeting but fell almost 100 basis points from those levels as markets started to factor in a Fed pivot. However, Fed has reiterated several times that it is not looking to reverse its rate hikes anytime soon.
At the Jackson Hole Symposium last month, Powell said, “restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy.” He added, “We are moving our policy stance purposefully to a level that will be sufficiently restrictive to return inflation to 2%.”
US Inflation Rate is Way Ahead of Fed’s Target Range
US August CPI was 8.3% on an annualized basis, which was way ahead of the 8.0% that economists were expecting. On a monthly basis, CPI rose 0.1% while core inflation rose 0.6%. Both these metrics were far worse than expected and analysts were expecting CPI to fall 0.1% while core inflation to rise 0.3%
Treasury yields spiked after the CPI release. Notably, the two-year Treasury is now near 4%. Bond guru Jeffrey Gundlach meanwhile is bullish on bonds and advises investors to invest in bonds.
Treasury yields and prices are inversely related. A fall in bond yields leads to a rise in bond prices. While the Fed continues to raise rates, many believe that it will soon resort to rate cuts. Gundlach also believes that the Fed is making a mistake of “over tightening.” Cathie Wood is also of the view that the US is headed for deflation.
US Treasury Yields Spike as Markets Brace for More Rate Hikes
US Treasury yields are rising before the Fed’s meeting. Notably, CME’s Fed Watch Tool shows that traders see an 18% probability of a 100-basis rate hike this month while the remaining 82% see a 75-basis point rate hike.
A month back, traders were almost equally divided between a 50-basis and a 75-basis point rate hike at the Fed’s September meeting. Traders have since been raising the odds of a higher rate hike and most now see a 75-basis point rate hike.
The US Treasury yield is also adjusting to the new expectations and the 10-year yields have risen to the highest level since 2011. However, the yield curve remains inverted, which many see as an indicator of an impending recession.
Last week, FedEx talked about a global recession after posting dismal earnings in its fiscal first quarter of 2023. The US GDP contracted in the first and second quarters of 2022 but the economy is still not in a recession officially.
Rising Treasury Yields are Negative for Growth Stocks
Growth stocks have crashed this year amid the rise in Treasury yields. However, there are some investments that can outperform during inflation.
US inflation is way above what the Fed is comfortable with. From calling inflation “transitory” in 2021, the Fed now worries that inflation might become “entrenched.”
Debt funds and ETFs have underperformed this year amid the rise in Treasury yields. While some market participants still believe a Fed pivot would come sooner than later, sticky inflation is making the US central bank’s job quite tougher as it tries to tame inflation without triggering a recession.
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