Bond traders step back from 3% to watch Powell navigate 'Fedspeak'

Bloomberg/New York

Bond traders came the closest in four years to a 3% yield on the 10-year Treasury note. Whether it breaches that level may be determined by how new Federal Reserve chairman Jerome Powell handles the limelight.
Powell, who took over from Janet Yellen this month, will speak before the House Financial Services Committee tomorrow and the Senate Banking Committee two days later, in what’s known as the Humphrey-Hawkins testimony. It’ll be the first time since Powell was sworn in that bond traders get a chance to parse every word from the new Fed leader, as they did with his predecessors.
Now, a fair amount is scripted – the Fed released its Monetary Policy Report on February 23 – and as a former member of the central bank’s board of governors, Powell has had years to hone the craft of Fedspeak that’s largely kept volatility at bay. He has also long been viewed by some as Yellen 2.0. TD Securities strategists “expect nothing new,” while the BMO Capital Markets simply says “yawn.”
But with an economy that the Fed says may already be beyond full employment, inflation showing signs of life, and fiscal stimulus on top of that, it may be a struggle for Powell to tamp down the optimism when in the Congressional hot seat.
“He’s going to try to emphasise continuity, gradualism, but I think it’s going to be hard for him not to sound a little bit hawkish, given the backdrop both in terms of inflation and in terms of growth,” David Riley, head of credit strategy at BlueBay Asset Management, said in an interview on Bloomberg Television.
Some strategists are already bracing for a more aggressive Fed and for further bond-market losses ahead, even though the benchmark 10-year Treasury yield fell on a weekly basis for the first time all year. One-time month-end flows and re-balancing may have contributed to the market’s rebound in the latter part of last week, which sent the 10-year yield to 2.87%. It reached a four-year high of 2.9537% on Wednesday after the Fed released minutes of its most recent policy meeting.
Treasury yields have climbed so quickly so far this year that some analysts are already reviewing their projections for the year. Bank of America Corp last week raised its 10-year US yield forecast for year-end to 3.25%, from 2.9%. Goldman Sachs Group boosted its estimate for the end of 2018 to the same level.
Goldman Sachs Chief Economist Jan Hatzius suggested the Fed could pick up the pace of tightening if inflation reaches policy makers’ target and the unemployment rate grinds lower.
Five rate increases this year is a “low probability,” but the bank sees four in 2018 and another four in 2019. As of now, Fed policy makers only anticipate moving three times this year and two to three times next year.
If Powell hints that he and the Federal Open Market Committee are moving towards a more hawkish path, it would be a “bearish shock” that would roil five-year Treasury notes in particular, according to BMO.
“He has to be really careful about over-hiking late in the cycle here as the enthusiasm continues to go up,” said Michael Collins, senior investment officer at PGIM Fixed Income, which oversees more than $700bn.
Bond traders know Yellen was painstakingly measured in her words. They’ll soon find out just how much continuity Powell brings in live testimony.