Let’s Get This Over With

I just mentioned to someone that I wish I got a dollar for every time I’ve heard or seen the phrase “hawkish cut” this week.  I’d certainly be able to treat myself to a very nice dinner.  (I thought of suggesting a drinking game, but that could be lethal.)  In any case, it’s about time to stop speculating about what might happen and instead learn the outcome.  Since I suspect that many of you are reading this after the event, I’m going to offer a quick focus on some things to watch in the coming days.

I’ve gotten several questions about the 10-year note yield in recent days.  It appears that some investors are becoming concerned that either the current FOMC or one led by Chair Powell’s successor will be even less concerned about the “stable prices” portion of the Fed’s dual mandate.  The President has made it quite clear that he desires lower rates, and it seems as though any serious candidate for the Federal Reserve Chair would recognize such a willingness to at least pay lip service to that desire as a prerequisite for consideration.  Kevin Hassett, the current director of the National Economic Council, is widely expected to be the nominee (ForecastEx shows a 72% “Yes”) and he has done little to dissuade us from that notion. 

To be fair, however, the Fed has not shown much concern for the fact that inflation has been running above the Fed’s 2% target for several years.  That hasn’t offered much negative impact on bond yields – and certainly not on stock prices – over that period.  But it appears that the “bond vigilantes” might be limbering up right now.  We have seen 10-year yields tick up in recent sessions, causing them to test a 4.20% resistance level and widen their spread against 2-year yields.  This morning’s test of the 4.20% level was successful, with the 10-year rate slipping back to 4.16% after rising in the morning.

10-Year Treasury Yields, 1-Year Candles with 30-Day Moving Average (green)

Source: Bloomberg

It’s not as though we haven’t seen higher yields recently; 4.20% would have been a desirable goal earlier this year.  They could rise another 20-basis points without much ill effect on stocks.  But the direction makes a difference.  Yields jumped during the post-election enthusiasm, plunged and bounced during the tariff chaos in April, and then resumed their downward trajectory for most of the ensuing months.  A reversal of that trend could change stock market psychology, but only after we have convincingly broken what is now a three-month trading range.

Something similar applies to the 2-10 spread.  Since rising earlier this year, we have been in a 40-60 bp trading range since April.  Again, it would take a convincing break of that trading range to take us back to the steepness that prevailed in late 2021.  The spread tightened throughout 2022, a period during which stocks dropped, but that was because the Fed was busy raising short-term rates.  That pushed up 2-year yields while longer rates remained relatively stable because those moves were perceived as stabilizing inflation rather than raising it.  A move to a steeper yield curve in the current environment would reflect greater inflation fears.

2-10 Yield Spread, 5-Years (white dots), 30-Day Moving Average (green line)

Source: Bloomberg

Despite the importance of today’s FOMC meeting, it is not likely that we will see this issue fully resolved this afternoon.  It will rely more on the future leadership of the Fed and its reaction to the data that we will belatedly learn in the coming weeks.  We can concern ourselves with the short-term movements stemming from the FOMC meeting and press conference this afternoon and focus on this in the weeks to come.