Treasury yields increase as Fed anticipated to announce rate cut

Yields rise pre-Fed: US Treasury yields climbed on Wednesday as the Federal Open Market Committee (FOMC) prepared to conclude its policy meeting, where a rate cut is widely expected for the first time in four years. This move signals confidence that inflation is under control and economic growth remains steady but not excessive.

The anticipated rate cut's magnitude, whether 25 basis points (bps) or 50 bps has been a point of intense debate leading up to the meeting, which began on Tuesday and will wrap up with an announcement at 2 pm EDT/1800 GMT.

Yields rebound strongly

Yields have been recovering from 16-month lows earlier this week following unexpectedly strong economic data. The benchmark 10-year Treasury yield dropped to 3.599 per cent, its lowest level since May 2023, after news of stronger-than-expected retail sales in August. On Wednesday, it was up 3.7 bps to 3.686 per cent.

Thirty-year Treasury yields rose by 3.9 bps to 3.99 per cent.

On the shorter end of the curve, the two-year yield continued its recovery after hitting a two-year low on Monday. It was up 4 bps to 3.646 per cent, marking a six-day high.

Fed officials have indicated their readiness to lower rates now that the tightening cycle from March 2022 to July 2023 has brought inflation under control. The focus has shifted to employment concerns following recent signs of a slackening labour market.

Reuters polls show most economists expect the central bank to reduce the Fed funds target range from 5.25 per cent-5.5 per cent by 25 bps, marking the first easing since the pandemic's onset in March 2020. This is based on the view that the economy is not at risk of a recession.

Rate cut odds drop

However, US rate futures currently reflect a 59 per cent chance of a 50 bps cut, down from 65 per cent on Tuesday. Futures traders also anticipate about 115 bps in cuts by the end of this year and 241 bps by September next year.

“There are some signs of fragility, but they don’t strongly suggest that a recession is imminent,” noted Ron Temple, chief market strategist at Lazard.

The yield spread between two-year and 10-year notes narrowed to 3.5 bps, compared to 5 bps late Tuesday. This slight flattening indicates that the market has slightly adjusted its rate cut expectations.

Demand for a 20-year note auction on Tuesday was weaker than expected, hinting at a pullback by some investors anticipating a 50-bp cut at Wednesday’s meeting.

Wednesday’s data on August housing starts and permits added to this week’s positive surprises, with housing starts jumping 9.6 per cent from July, according to the US Census Bureau.

The 10-year TIPS breakeven rate was last at 2.123 per cent, suggesting the market expects inflation to average about 2.1 per cent annually over the next decade, almost aligning with the Fed’s 2 per cent inflation target.