The US Federal Reserve is not just telegraphing its intention to start tapering bond purchases, but blaring it through loudspeakers. Yields on US Treasuries are responding appropriately.
Yield on the benchmark 10-year note rose more than 2 basis points on Monday, to more than 1.48%, after spiking briefly above 1.50%. This compares to about 1.3% ahead of Wednesday’s press conference with Fed Chairman Jerome Powell, when he said it would probably take just one “decent” jobs report for the Fed to start reducing its bond purchases.
Investors took that to mean the Fed would begin tapering at the Nov. 2-3 meeting of the Federal Open Market Committee.
As the Fed reduces its purchases of Treasuries—currently running at $80 billion a month—this will remove a price support and allow the government bond yields to drift upward. Following Powell’s comments, investors are expecting the Fed to move quickly and end its bond purchases by the middle of next year.
The dovish head of the New York Fed, John Williams, added his voice to some of the Fed’s hawks last week when he said on Monday that “moderation in the pace of asset purchases may soon be warranted.”
A higher-than-expected increase in durable goods orders reported on Monday provided further evidence that the economy is surging ahead in spite of supply-chain constraints.
Durable goods orders for August rose 1.8%, triple the forecast rate of 0.6%. In addition, the dip of 0.1% reported for July was revised upwards to show a gain of 0.5%. Analysts said a sharp swing in orders for transportation equipment accounted for the August surge.
A vote in the House of Representatives on the $1 trillion infrastructure bill already passed by the Senate is scheduled now for Thursday, and House Speaker Nancy Pelosi says she is confident it will pass. The much more controversial spending bill put originally at $3.5 trillion is still being hammered out, and Pelosi indicated it would almost certainly come in at a lesser amount.
The resurgence of a so-called, reflation trade is a two-edged sword because it means not only a growing economy but an increase in inflationary pressures from supply-chain disruptions, higher oil and energy prices, and hefty boosts in shipping costs that may not abate as quickly as the Fed originally hoped.
Gain in sovereign bond yields in the eurozone mirrored those in Treasuries. Yields on the benchmark 10-year German bond surged more than 5 bps from Friday, hitting near minus 0.20% before retreating to below minus 0.22% after investors realized the national elections in Germany effectively rule out a left-wing coalition because the far-left Linke party didn’t win enough seats to round out a majority.
Social Democrats came out on top, but the likely chancellor, Olaf Scholz, has been decidedly moderate as finance minister in the outgoing grand coalition under Chancellor Angela Merkel. An alliance with the Greens environmental party and the business-friendly Free Democrats would give a centrist cast to a Scholz government. Investors were cautiously optimistic that such a coalition could lead to more public spending in Germany—and more borrowing.
Investor interest quickly shifted then to possible tightening by central banks. Yields on Italy’s 10-year government bond were marginally higher on Monday following a surge last week in the wake of the Powell remarks. France’s 10-year bond yield followed a similar pattern.