Bond Report: Treasury yields pull back ahead of Fed meeting kickoff

U.S. Treasury yields slipped Tuesday, a day after the yield on the 2-year note ended at a 19-month high, ahead of the start of a pivotal, two-day Federal Reserve meeting that’s expected to see policy makers unveil their plan to wind down monthly bond purchases.

What are yields doing?

The yield on the 10-year Treasury note

fell to 1.551%, compared with 1.573% at 3 p.m. Eastern on Monday.

The 2-year Treasury note yielded

0.478%, versus 0.513% on Monday afternoon, when it ended at its highest since March 18, 2020.

The 30-year Treasury bond

was yielding 1.963%, down slightly from 1.968% on Monday.

What’s driving the market?

Investors are focused on the Fed, which will deliver a policy statement Wednesday afternoon followed by Chairman Jerome Powell’s news conference. The Fed is fully expected to lay out plans to begin tapering its bond purchases, a process that’s expected to end by the middle of next year.

A key question is whether Powell will push back against a shift in market expectations that has seen traders price in the potential for multiple policy interest rate increases in 2022. Powell, in the past, has emphasized that the end of Fed bond purchases wouldn’t necessarily lead to the immediate start of a series of rate increases.

But investors have started to price in a more aggressive stance by the Fed and other major central banks in response to inflation pressures that have been more persistent than expected. That’s resulted in a significant flattening of the yield curve — a line plotting yields across all maturities — in the U.S. and other developed economies.

The curve flattening is also seen underlining concerns that a more aggressive tightening of monetary policy could cause a significant economic downturn.

The Reserve Bank of Australia on Tuesday said it would stop using yield caps and signaled it would begin to raise rates earlier than previously anticipated. The RBA had previously said it wouldn’t be in a position to raise interest rates until 2024 at the earliest.

What are analysts saying?

“Investors seem to be worrying that the pace of rate hikes necessary to mitigate inflation may have to come at a swifter pace than current Fed guidance,” wrote analysts at Morgan Stanley Wealth Management, in a note.

“The weakening of the market’s faith in the Fed’s inflation stance is also evident in the 2-year/10-year yield curve, which is flattening, indicating skepticism about economic growth prospects,” they wrote. “This is where we think bond investor pessimism is excessive: A ‘hotter but shorter’ cycle suggests that the yield curve steepens anew, which could help to reignite cyclical stocks.”

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