If interest rates end the week higher, there's a good chance the Fed will have had little to do with it.
Instead it may be a whole string of events, including the Bank of Japan's meeting Tuesday, that could send bond yields higher, at a time of record short positions in U.S. 10-year Treasury futures. Bond yields move opposite price, so short positions mean investors expect yields to move higher.
"This could be one of the most volatile weeks of the summer," said George Goncalves, head of U.S. rates at Nomura.
Strategists have been eyeing the recent climb in the 10-year Treasury yield, which is flirting with 3 percent, just ahead of the Fed's meeting Tuesday and Wednesday. But it's not the Fed alone that's been driving the yield on the benchmark 10-year, the rate that affects all types of business and consumer loans, including home mortgages.
While yields typically move higher around Fed meetings, in the past week it's been the Bank of Japan that's had the most influence, and the move has been in tandem with the runup in yields on the Japanese 10-year bond. There has been speculation that the BOJ could tweak the language around its own easy money policy, which includes changing its policy of targeting a zero yield on its 10-year. Strategists say there's a chance the BOJ could signal a change in the range is coming.
"I feel like where there's smoke there's fire. ... We think that pending some sort of review put in place, they're looking to do operational tweaks," said Goncalves. "They'll say they're still committed to the easing framework. It's semantics at the end of the day. They're going to walk a fine line." Goncalves said it may be that the Bank of Japan suggests changes are coming and ultimately takes some action in October to change its rate target or what its purchases will look like.
But some say they expect no movement from the Bank of Japan, and that could roil a market that's been setting up for a change in the policy regime and the global rates that moved with it.
At the same time, the Fed's Wednesday afternoon rate decision and statement are factors that may not have that much impact since the Federal Reserve is expected to keep rates on hold this time. They also don't expect surprises because Fed Chair Jerome Powell recently discussed the Fed's policy and economic views at recent congressional hearings.
But one factor that could affect the market is if the Fed decides to tweak its language on keeping policy accommodative. Tom Simons, money market economist at Jefferies, said if the Fed adds that it will keep policy accommodative "for now," signaling it sees an ultimate end to tightening, that could spark speculation that the Fed is getting closer to a neutral rate, where it would not have to raise rates unless inflation picks up. The Fed's target fed funds rate is currently at 1.75 to 2 percent.
Strategists say the U.S. 10-year could easily pierce 3 percent this week, but where it goes from there depends on the cumulative impact of events, including an announcement Wednesday morning from the U.S. Treasury on how much money it needs to borrow and how it will borrow it. There is also the Friday employment report for July, and other central bank meetings, including the Bank of England and India's central bank, both of which could raise interest rates.
The 10-year has risen as high as 2.99 percent recently and was at 2.96 percent in afternoon trading Monday. The Japanese 10-year hit a high of 0.113 percent, its highest since February 2017, but strategists said the BOJ intervened to stem its rise and it was at 0.101 percent later in the session. The German bund yield also moved higher Monday on stronger regional inflation with the German 10-year yield at 0.444 percent.
The easy policies of foreign central banks have served a big role in keeping a lid on Treasury yields, since the higher-yielding U.S. securities are attractive to investors, in a world where rates have been held at or below zero. The 10-year yield was last at 3 percent June 13, the day of the last FOMC meeting, when the Fed raised interest rates by 25 basis points. While the 10-year would move, the Fed's policy moves have a more dramatic and instant effect on the 2-year yield, which was lower on the day Monday at 2.66 percent.
Strategists say it's unclear even if the 10-year does jump above 3 percent this week how long it will stay there, since August is usually a positive month for bonds, pushing prices higher but yields lower. The 10-year hit its high yield for the year of 3.12 percent in May, and strategists say it's not likely it will reach that or push through it right away, unless there are big surprises in this week's announcements.
The U.S. Treasury Wednesday morning is expected to announce how much it needs to borrow and in what sectors. The market has been busy speculating what it means for different issues, and the expectation is that the Treasury will add more 2-year and 3-year notes, rather than longer-dated 10-year and 30-year bonds.
"Frankly, to me the refunding could be potentially a more significant catalyst than the Bank of Japan. I don't expect anything terribly exciting from the Bank of Japan. I think they will reaffirm their willingness to throw down an unlimited amount of stimulus. I don't think there will be too many tweaks," said Boris Rjavinski, director of rates at Wells Fargo. "If anything they may mention something around slightly wider ranges around this yield curve target. That's why the 10 year [Japanese] yield traded up 10 basis points. It causes so much excitement because JGBs [Japanese government bond] yields haven't gone anywhere for years. Even 10 basis points seems like a sharp move."
Rjavinski expects the government to add $3 billion in additional securities in the third quarter in the 2-year and 3-year sectors, and $1 billion in the other, from 5-year notes to the 30-year bond.
Friday's employment report is expected to show 190,000 jobs were added in July, but the number markets are watching is the 0.3 percent gain expected in hourly wages. Anything higher could send yields higher, since it could signal a potential pickup in inflation. Gains in wages have been sluggish.
"We're going to chop around 3 percent until we get past Friday's number," said Ian Lyngen, head of fixed income strategy at BMO. "I don't think we're going to break 3.12 even in a massive sell-off. But I think we're just still in the range. There hasn't been anything truly new to challenge the range."