Evening Brief – 04.17.24
5%?
Federal Reserve Chair Jerome Powell admitted that progress on the inflation front has stalled and the case for interest rate cuts has become less compelling. The U.S. Treasury market, meanwhile, has been essentially making the same case for weeks now.
“More recent data shows solid growth and continued strength in the labor market, but also a lack of further progress so far this year on returning to our 2% inflation goal,” Powell said at an event on Tuesday in Washington on the Canadian economy. “The recent data have clearly not given us greater confidence, and instead indicate that it’s likely to take longer than expected to achieve that confidence.”
The U.S. 10-year Treasury yield rose to 4.69%, the highest level in more than four months on Tuesday before pulling back about nine basis points today. Still, momentum and investor positioning suggest the October 19 peak of 4.99% has a good chance of being tested.
Meanwhile, odds of an interest rate cut this year continued to decline, with most investors now predicting just two cuts. The odds of a June cut have dropped to 15%, with the first cut now expected in September. Moreover, 2025 rate-cut expectations have declined as well.
To put the 10-year Treasury yield in perspective, one can compare it to estimates of the term premium, or the compensation that investors demand for the risk that interest rates can change over the life of the bond. A higher (lower) term premium corresponds to higher (lower) Treasury yields.
The challenge, of course, is that term premia are not immediately observable, therefore economists employ models to approximate the data. According to FRED data, the U.S. 10-year Treasury yield appears to have risen more than two estimates of term premia would suggest. The question is whether the forecasts are incorrect, or whether the Treasury market is overcompensating for the anticipated risk.
Additional inflation data will be required to settle the issue. Stubborn inflation prints have recently encouraged the bond bears to demand a greater term premium, and until there is compelling evidence to the contrary, the market will remain unconvinced that disinflation is still underway.
It would not come as a shock if the U.S. 10-year Treasury yield approached 5% in the coming weeks. Consequently, higher interest rates and higher-for-longer mean that the threat to equities from the risk-free rate will last longer.