You may not have noticed it, but before last Wednesday the bond market had been in kind of a mini-rally for the previous month. On Tuesday, the benchmark 10-year Treasury note fell to 2.32%, its lowest level since the end of November. That was down from 2.60% in mid-December, which also happened to be its highest mark since 2014.
But by the end of the week the yield on the 10-year had jumped back up to 2.47%, up 15 basis points in just three days. What happened to put the brakes so suddenly on this rally? Why, Janet Yellen spoke, and when Janet Yellen speaks – well, you know the rest.
But did anyone really listen?
On Wednesday, in a speech to the Commonwealth Club in San Francisco, the Fed chair said that she and most Fed officials expect to raise rates “a few times a year” through 2019, when its target interest rate is projected to reach 2.9%. For Yellen, those were relatively hawkish remarks. But did she really anything that we didn’t know already or that she hadn’t said before that would trigger a selloff in bonds?
From my perspective, I didn’t hear anything different from what the Fed announced back in mid-December, when it raised short-term interest rates by 25 basis points, its first rate increase in a year. So why should the bond market sell off when nothing really changed? Once the dust settles and people clear their heads, is there not a good reason for the December-January bond rally to resume? Or was that just a dead-cat bounce, and rates are now headed north again?
Back on July 8, the yield on the 10-year bottomed out at about 1.36%, which was also its lowest level in several years. Over the next five months the yield nearly doubled, reaching the aforementioned 2.60% in mid-December. Most of that increase, or more than 80 basis points, occurred following Donald Trump’s unexpected election victory. The trigger was speculation that Trump’s avowed policy preferences – pro-business, deregulatory, low taxes – were inflationary and would therefore boost interest rates, which of course they did.
At the same time, the Fed has been telling us that the U.S. is now at full employment – if you choose to believe the government’s official unemployment rate – and therefore it must start raising the federal funds rate in order to prevent the economy from “overheating.” It did in fact do so at its December meeting, while indicating very strongly that we can expect at least three more rate increases this year, as Yellen reiterated last week.
But did Yellen actually say anything else last week that would send the bond market into reverse? “Our interest-rate expectations will change as our outlook for the economy changes,” she said. Nothing unusual or profound there.
So what’s happened to change the market’s thinking? What drove the December-January mini bond rally, and can we expect it to continue?
I think we can.
The most obvious thing is that last year’s sharp rise in interest rates and bond yields – nearly 100 basis points in five months – was too much too fast. Quite clearly, bonds were way oversold, so a correction or bottom-fishing, whatever you want to call it, was to be expected. The market can’t move that far that fast without a correction, whether the market’s rising or falling.
Lots of people got caught up in the post-election euphoria. After all, look at what happened in the stock market. The Dow Jones Industrial Average jumped more than 11% from November 4 – the Friday before the election –to topping out at 19945 on December 27. Since then, it’s been basically flat.
Nothing wrong with being optimistic, but maybe we do have to tone down our expectations and wait for things to actually happen.
But is that all that’s going on here, or are we really engaged in a full-fledged rally, with bond yields poised to keep falling and prices rising? What can we expect going forward over the first few months of the Trump presidency?
It’s clear that we may have to lower our expectations, not because that what Trump wants to do is unreasonable or undoable, but it simply takes time to accomplish. Despite the all recent media stories about his supposedly low approval ratings, let’s try to remember that Trump has been president all of a few days. While the policy ambition Trump showed in his inaugural address is noteworthy and admirable, he’s going to need some time before he can start to deliver on his promises, given the obstacles and political opposition he faces.
After all, Trump has given himself and his administration some tall orders: abolish and replace ObamaCare; dismantle or at least modify Dodd-Frank; lower corporate and individual taxes; build the wall with Mexico; renegotiate our trade agreements. None of those will get done in a couple of days.
So, while bond yields are likely to move higher by the end of this year, I think the next move is downward, to compensate for last year’s big rise. Yellen and the Fed have been criticized – and rightly so – for their many failures to communicate. Last week wasn’t one of them.
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INO.com Contributor - Fed & Interest Rates
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.