US Treasury 10-year yields (%) daily chart
This wasn’t supposed to be part of the script. At the start of the year, the idea of 5% yields would’ve been an improbability. It was all about how many rate cuts the Fed will be doing. At the time, markets were debating between six or even seven rate cuts. Yet, here we are now deliberating over the possibility of just one rate cut this year.
That has seen a selloff in bonds over the last few months, with things picking up in April in particular. We’ve gone from March to June to September, and now perhaps November on the outlook for the Fed’s first rate cut. And that is the key reason for the run higher in yields during this period.
As 10-year yields sit near 4.70% ahead of the Fed later today, a critical question is whether it has the potential to move higher to 5%.
Goldman Sachs calls this the pain threshold for stocks in their latest note:
“While there is no ‘magic number’, historically bond yields at around 5% is when higher yields become a clear problem for equities — that is the point where the correlation with bond yields is no longer decisively positive.”
So, what would it take for yields to move decisively higher from here?
Considering that traders are still roughly pricing in one rate cut for the year, it means having to run that back entirely. For that to happen, I’d argue that it would require a more hawkish Fed. The key word there being hawkish. In that sense, even a less dovish Fed may not be enough to settle the conviction.
In other words, the answer to that is for the Fed to possibly consider rate hikes.
For now, I don’t think we’re at that stage yet. But as long as Powell keeps the door open, traders could easily use that to turn it into something more. As such, even the slightest indications of the Fed maybe having to hike again would be more than enough. However, I’d be surprised if Powell does offer that up later today. My take is that the Fed is not that desperate yet.
But if prices continue to hold up in the months ahead and the US economy continues to run as it is, it definitely raises the odds.
And if yields remain underpinned as such, it will keep the dollar in favour with USD/JPY especially staying supported. And that’s not quite what the BOJ would like to see happen especially with the inflation trend in Japan not working for them lately.