Treasury yields edge up as investors ready for Fed’s policy update

U.S. Treasury yields climbed modestly on Wednesday as investors await the most recent statement from the Federal Reserve, which could offer insights about the economic outlook and inflation.

What yields are doing
Fixed-income drivers

Investors will focus on the Fed’s policy update due at 2 p.m. Eastern Time later in the session, which will be followed by a news conference by Jerome Powell, the chairman of the rate-setting Federal Open Market Committee, at 2:30 p.m.

Although the U.S. central bank is not expected to make any substantial policy changes, investors will be watching for clues on when the central bank may start to withdraw the support for markets and the economy that was implemented to mitigate the impact of the COVID-19 economic shock.

Specifically, investors want to know the Fed’s timing on scaling back monthly purchases of $80 billion in Treasurys and $40 billion in mortgage-backed securities and when it might raise interest rates.

Earlier this month, during semiannual testimony to Congress, Powell said that the Fed won’t hesitate to raise interest rates to tamp down overheated inflation, but has thus far viewed evidence of hotter-than-expected pricing pressures as a temporary phenomenon, pegged to increased demand and supply-chain bottlenecks in the aftermath of the economic recovery from COVID.

Treasury yields have been anchored lower despite recent inflation data — leading many to speculate that buying in Treasurys has been due to other factors, including reduced issuance, or that debt investors believe that inflation will be short-lived.

Ahead of the Fed update, a report showed that the U.S. trade deficit in goods rose 3.5% in June to a record $91.2 billion, reflecting a strong appetite among Americans for imports as the U.S. economy recovers from the coronavirus.

What strategists and traders say

“The FOMC is likely to leave rates, the pace of asset purchases and guidance all unchanged today,” wrote strategists at UniCredit in a research report.

“The[FOMC] will begin to formally discuss plans for tapering asset purchases at this meeting, but we do not expect any clear hint on the timing or composition of tapering. There are two main reasons for this. First, there are a range of views on the FOMC regarding tapering, and it will likely take a while to build a consensus. Second, most FOMC participants would like to wait for incoming data to be able to make a clearer assessment of the economy and the progress that has been made toward the Fed’s goals, as reopening effects and fiscal-stimulus effects fade and temporary factors weighing on labor supply ease,” the strategists wrote.

In a separate note from Monetary Policy Analytics, economists Larry Meyer, Kevin Burgett, and Derek Tang said that they also see the taper debate advancing at the current meeting, but falling short of a final decision.  “We still expect announcement of tapering late in the year and for reduction of UST and MBS to start at the same time,” they said.

The Treasury market has drifted into a “pre-FOMC holding pattern with 10-year yields anchored to 1.25% and 30s at 1.90%,” said BMO Capital Markets strategists Ian Lyngen and Ben Jeffery. “Expectations are for the Fed to maintain the present policy stance and, if anything, add a degree of caution as it relates to emerging from the pandemic. Cases of the delta variant continue to garner market attention as a reminder that mutations of the coronavirus will remain a risk even beyond the current episode. While the US is unlikely to see the return of 2020-style lockdowns and covid restrictions, hesitance on the individual level to reengage with the in-person economy has become the primary risk. “

“It’s with this backdrop that we’ll be attuned to any insight Powell offers on the progress on the jobs front and expectations for the delta variant to have a meaningful impact on the recovery,” Lyngen and Jeffery wrote in a note Wednesday. “Today’s events are more likely to be about Fed nuance than monetary policy changes and as a result the price action will be a function of investors angst.”

Lyngen and Jeffery said their baseline assumption is that “the Fed comes across notably more dovish than the impression left by the June FOMC meeting.”

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