US interest rates are zipping higher, but don't blame the Fed
- U.S. interest rates are moving higher because the U.S. government is expected to take on more longer-term debt, and global central banks are stepping back from some of the easy policies adopted in the financial crisis.
- The widely-watched 10-year benchmark Treasury yield jumped through 3 percent for the first time since June 13, on a combination of factors, including stronger ADP jobs data, an announcement on Treasury borrowing needs and signs the Bank of Japan may be tweaking its policy.
- The Fed, meanwhile, was meeting Wednesday and was not expected to take action, but analysts expect the 10-year to remain on an upward trajectory at least to Friday's government jobs report.
U.S. interest rates are moving higher because the U.S. government is taking on more longer term debt and global central banks are stepping back from some of the easy policies they adopted in the financial crisis.
The benchmark 10-year Treasury yield jumped through 3 percent for the first time since June 13, after languishing in a range below 2.90 percent for most of the summer. It is widely watched because it is the key rate that influences the cost of mortgages and other consumer and business loans, and is affected by interest rates worldwide.
The Fed was meeting Wednesday and was not expected to hike interest rates, though the market expects it to raise in September and possibly again in December. The U.S. mostly leads in terms of exiting long running easy money policies, and U.S. rates are higher and more attractive to bond investors than those of other major sovereigns.
The 10-year yield cracked 3 percent Wednesday on a combination of factors, including stronger ADP jobs data, an announcement on Treasury borrowing needs and signs the Bank of Japan may be tweaking its policy.
The U.S. Treasury Wednesday announced changes to its bond sales this quarter that will help it meet its $329 billion borrowing needs for the third quarter. It surprised the market by adding more debt issuance in the 5-year sector than was expected.
The government is expected to keep increasing its borrowing to pay for tax cuts and federal stimulus programs, which also could push interest rates higher.
"Between supply pressure, the Bank of Japan, and a decent economy, unless you get more trade fears, the path of least resistance is higher," said John Briggs, head of strategy at NatWest Markets.
The actions of other global central banks can have a strong pull on U.S. rates. The super low yields of Japan and Europe have long been blamed for keeping the U.S. 10-year yield low, while the U.S. economy is clearly strong and the Federal Reserve is lifting interest rates. A move up in Japanese bond yields and German yields has factored into the recent rise in the U.S. 10-year yield.
"Because Japanese yields are so low, money has been going overseas to other higher yielding stocks and bonds, particularly in Europe," said Briggs. "But if you look at it very simply, Japanese investors are getting higher yields abroad than at home. If you give them higher yields at home, it makes those other sovereigns less attractive and our yields should move higher, either as demand wanes or to attract those or other investors. Japan has been an anchor for sovereign bonds for so long. If you move the anchor up, it lets everything else rise."
Briggs and others said the if the 3 percent holds for now, the next target on the 10-year would be 3.12 percent, its high from May of this year.
Bond yields move opposite price. How high the 10-year yield can move is unclear, since August is also often a bullish time for Treasurys. But the market is anticipating more bond issuance at longer terms, said George Goncalves, the head of U.S. fixed income strategy at Nomura.
"The way the market is reacting it feels the market is understanding there's eventually a need for Treasury to issue more [debt], and in 10-years too," he said. "The fact they moved to increasing short term Treasurys and now they're moving out the curve, to the 5-year, the next stop is the 10-year, and I think the market is lining up for that."
The Treasury had been increasing shorter term debt, in 2-year and 3-year notes, at a faster pace than the longer end 10 years. On Wednesday it increased 5-year issuance by $1 billion a month, instead of $1 billion for the quarter as expected.
The markets are now waiting for the Federal Reserve, which ends its two-day meeting Wednesday afternoon with a 2 p.m. statement. Even though it is not expected to take action, Treasury yields often rise ahead of its announcements. The 2-year Treasury yield rose to 2.68 percent in morning trading. The shorter-term 2-year reacts more to Fed policy moves than the longer-term Treasurys, such as the 10-year.
The Fed's next quarter-point increase in its fed funds target rate range is expected in September, but markets are watching its statement for any changes or clarification on future policy moves. Friday's July employment report is the next big event for markets after the Fed.
The ADP report earlier Wednesday showed that 219,000 jobs were added in July, compared to market expectations for 185,000. The ADP report is like a warmup for the Friday government employment report, and traders see a chance that the ADP number could be signaling a hotter report than economists were expecting. According to Thomson Reuters, economists were looking for 190,000 jobs Friday and an increase in average hourly wages of 0.3 percent.
The wage number has become much more important to the market because it signals potential for inflation, and it has been stubbornly softer than economists believe it should be given the economy's consistently strong job growth.
"Friday [payrolls data] is going to be important," Goncalves said. "I think this does set us up for next week. There will be another crack at the market to lock in 3 percent on the 10-year."
Goncalves said the government's auction of $26 billion 10-year notes on Wednesday will be influenced by how the market moves this week. The Bank of Japan, meanwhile may have more impact on Treasury yields this week than the Fed. Global yields fell after Bank of Japan didn't change its policy in its Tuesday announcement.
In a press briefing, the BOJ signaled it could let the now zero target on its 10-year yield become a band of 20 basis points on either side of zero. Jim Caron, fixed income portfolio manager at Morgan Stanley Investment Management, said the market misconstrued the BOJ message, and the Japanese 10-year fell from around 0.11 percent to 0.05 percent Tuesday.
On Wednesday, the yield snapped higher to 0.13 percent, its highest since January 2016.
"Somehow they've adopted more flexibility around their yield curve," Caron said. "You inject a wider range, you're injecting more volatility."
Caron said the BOJ is trying to help Japanese banks, which have been struggling in the low rate environment, but he doesn't see it as an end to easy policy. "They're just loosening their belts so they can feast some more," he said. The BOJ did tweak its asset buying program this week, including shifting its buying to more ETFs tied to the Topix index from the Nikkei, after it has become a major holder in stocks of many Nikkei-listed companies.
For its part, the European Central Bank is also stepping away from easy policies, though more stridently. It is expected to soon end its asset purchase program. That, too, could pressure global rates higher.
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