A tight labor market and more expensive raw materials are expected to goad prices higher throughout the year, though manufacturers have thus far been hesitant to pass on the steeper costs to consumers. Fed bankers, meanwhile, have signaled that they would not be alarmed if inflation overshot its target as the economy rebounds from a historic spell of stagnant prices.
The central bank is widely expected to hike the federal funds rate 25 basis points in its September meeting in what would be its third hike so far this year, a move Cleveland Fed President Loretta Mester praised on Wednesday.
“The economy can certainly handle two more increases this year,” Mester said in an interview with The Wall Street Journal. “We could end up getting behind if we don’t keep moving things up, so I’m very comfortable, if the economy stays on the path it’s going that we move rates up as appropriate this year.”
Others worry that the central bank may be too aggressive in its plans to raise borrowing costs. The so-called yield curve between two-year Treasury note yields and 10-year note yields is moving closer and closer to zero, meaning that there is less payoff for investors willing to hold debt for a longer period of time.
"The fact that the economy is doing well doesn’t necessarily mean inflation overall should go up," said Krishna Memani, chief investment officer at OppenheimerFunds. "It's the demographics, it’s the debt load, it’s the globalization: The point is that U.S. real rates, which had gone up, have come right back down. The Fed is having difficulty raising real rates right now."
At the latest reading, the spread between the yield on the 10-year note and the two-year note was 26.19 basis points, down from above 90 basis points early in the year.
When the yield on a shorter duration security rises above a longer duration security, or inverts, it is seen as a recession warning. An inverted yield curve has proven to be a reliable indicator over the years.
To some, the Fed's ability to keep raising interest rates on short-term Treasury notes could quickly cause the yield on the two-year Treasury (or other short-term bills or notes) to exceed other benchmark notes with longer maturities.
"The shape of the yield curve matters not because anything gets set in the marketplace because of it, but because it’s a shot across the bow for the policymakers," Memani added. "What I would advise Powell is hike a couple more times this year and see where we are. There’s no rush. What’s the point in being too doctrinaire?"
The Treasury Department auctioned $14 billion in 30-year bonds at a high yield of 2.958 percent. The bid-to-cover ratio, an indicator of demand, was 2.34. Indirect bidders, which include major central banks, were awarded 61.9 percent. Direct bidders, which includes domestic money managers, bought 10.3 percent.