A Fed Hike Will Send Treasury Yields Higher Right? Not So Fast

Good hike, bad hike.

That’s the game we’re playing on Wednesday and really, it’s more of a question. That is: is a hike good (in the sense that it confirms the Fed’s faith in the reflation narrative)?, or is a hike bad (in the sense that it will tighten financial conditions, possibly undercutting the equity rally, pressuring the dollar higher, and weighing on a recently beleaguered commodities complex)?

Good questions, both. One thing to note is that with rate differentials already wide thanks to policy divergence, a hike might well stimulate demand for US paper, putting a bid under the market and driving yields lower, not higher.

And my, oh my – if that happens and all of the shorts in the belly of the curve have to cover, it would be quite the spectacle. 

Belly

Below, find some color on this from Bloomberg’s Wes Goodman.

Via Bloomberg

Fed rate increases should send Treasury yields up, right? It looks more likely the opposite is going to happen following the expected central bank rate rise Wednesday.

  • The last two Fed hikes marked a peak in Treasury yields, and the same thing will probably happen now, said Toshifumi Sugimoto at Capital Asset Management in Tokyo. Higher borrowing costs keep inflation in check and support demand for U.S. government debt, he said

Hikes

  • Two-year break-even rates and oil prices are plunging, underscoring concern the Fed has yet to end the risk of disinflation
  • Benchmark 10-year yields have failed to hold above 2.6 percent, the level bond market guru Bill Gross said will signal the start of a bear market if sustained on a weekly basis. Instead of breaking to higher levels, rising yields are drawing demand
  • Treasuries offer a growing premium over their peers. U.S. two-year notes yielded as much as 223 basis points over like-maturity German securities earlier this month, the biggest spread since 2000 and another reason to favor U.S. debt
  • There will be many different issues to focus on from this meeting — the dot plot, the phrasing around the balance of risks, and any mention of balance sheet management — so the short-term reaction may be volatile. Don’t be scared off by any initial yield spike
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  1. Pingback: Trader: “Much more to come” for Treasury Rally, Dollar Slump – Biiwii.com

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