Following recent data, Federal Reserve Chair Jerome Powell admitted Tuesday that inflation’s progress has stalled and the case for a rate cut has weakened.
The Treasury market has been making the same argument for weeks, but when the top central banker says it out loud, the crowd takes notice.
“The latest data shows solid growth and continued labor market strength, but also a lack of further progress this year in returning to our 2% inflation target,” Powell said at a conference on Thursday. April 16.
“Recent data has clearly not given us greater confidence, and indeed indicates that it will likely take longer than expected to achieve such confidence.”
The yield rose to 4.67%, the highest since November 6. Now the question is whether the reference rate is still in a fluctuation range, or whether it is ready to reach the previous peak of around 5%, set in October.
The trading range hypothesis has taken a hit, but it is premature to write an obituary. As we wrote earlier this month, several “fair value” models for the 10-year yield continue to suggest the presence of a sizeable market premium, implying that the benchmark rate faces headwinds continuous increases.
Another approach to putting the market-based 10-year yield into perspective is to compare it to estimates of the term premium, which is the compensation investors demand for the risk that interest rates may change over the course of a given bond maturity.
A higher (or lower) term premium implies higher (or lower) Treasury yields. The problem is that term premiums are not directly observable and so economists use models to estimate the data. This is an inexact science, but still useful for developing additional context.
On this basis, it appears that the 10-year rate has risen more than warranted by two estimates of term premiums. The debate is whether the models are wrong or whether the Treasury market is overcompensating for expected risk.
In my opinion the conflict will be resolved, one way or the other, by the incoming inflation data, which is behind the recent increase in the 10-year rate. The latest inflation data has convinced the public to demand a higher yield premium, and until there is compelling evidence to the contrary, the market will remain skeptical that disinflation will persist.
No one knows where inflation is headed, but my overall model for core consumer prices still points to ongoing disinflation. Of course he could be wrong, but the track record of this pattern is encouraging and so for now I still expect pricing pressure to ease, albeit at a slower pace than recently expected.
Assuming the forecasts are accurate, when will the Treasury market revise its expectations accordingly? For the moment, such a realignment does not appear imminent. Accurate or not, the crowd is demanding a higher inflation premium, even if this demand is headed for an attitude correction. As a result, it would not be surprising to see the 10-year yield approach the 5% mark in the coming weeks.
What would push the policy rate above this level? For a possible answer, we need to wait for the release of the April CPI, scheduled for next month.
Tags: Powells warning pushes #10year Treasury yield breakout
