NEW YORK — Even with U.S. Treasury yields at their highest levels since the early 2000s, bets on the Federal Reserve's rate path this month keep shifting. Optimistic investors who see the rise in bond yields as a reflection of contained inflation and brisk economic growth are wagering that the Fed will pause its rate increases. Others argue a back-to-back hike cannot be ruled out, pointing out that current inflation readings do not yet capture a changed economic environment since September, including a surge in diesel prices, and that consumer sentiment is already deteriorating.
Futures on the federal funds rate on the 30th raised the implied probability that the Fed will hold its benchmark rate at the Oct. 27-28 meeting of the Federal Open Market Committee to more than 65% during the session, according to the CME FedWatch tool on the 1st. The odds of a 0.25 percentage point increase fell to the 34% range intraday. As recently as the 29th, the two outcomes had been nearly evenly split at 49.1% and 50.9%, meaning sentiment swung sharply toward a hold in a single day.
The probability that the Fed raises rates only once more this year also climbed to more than 60.0% from 49.4%. The odds of two increases fell to the 28% range from 42.2%.
The shift toward a hold followed the Commerce Department's report on the 30th that the personal consumption expenditures price index for August came in below expectations. The department said the August PCE price index rose 3.4% from a year earlier, 0.3 percentage points below the 3.7% forecast in a Dow Jones survey of economists. It rose 0.3% from July, matching forecasts. The core PCE price index, which excludes energy and food, rose 3.0% from August last year and 0.2% from the previous month, also below the 3.3% and 0.3% expected in the Dow Jones survey. The PCE price index is the inflation gauge the Fed weighs most heavily in setting its benchmark rate. With price pressures easing, market participants concluded the Fed had room to slow the pace of its increases.
Stronger-than-expected U.S. growth and steady employment data added to the case for a hold this month. The Commerce Department said the final reading of second-quarter gross domestic product growth was 2.2% on an annualized quarter-on-quarter basis, 0.7 percentage points above both the preliminary estimate released Aug. 26 and the 1.5% consensus. Private payrolls in September rose by 90,000 from August, according to Automatic Data Processing data released the same day, far exceeding the 68,000 expected.
The gap between the odds of a hold and a hike in October narrowed again within hours. The probability of a hold slipped to 61.8% and that of an increase rose to 38.2%, leaving neither path clear. The odds of back-to-back increases at the two remaining FOMC meetings this year also returned to the 30% range.
Behind the renewed decline in hold odds was a jump in U.S. Treasury yields. On the 30th, the yield on the 10-year Treasury note, the benchmark for global bond markets, climbed as high as 5.306% during the session, its highest since May 2002. That exceeded the 5.303% reached in 2007 during the global financial crisis. Solid U.S. growth pushed long-dated yields up first, while concerns over the prolonged war in the Middle East and diesel prices at their highest levels since September dragged short-dated yields higher as well. The fact that PCE inflation remains well above the Fed's 2% target also fueled the rise in Treasury yields.
Anshul Pradhan, head of U.S. rates research at Britain's Barclays, said in a report that the market continues to assume higher rates will prove cyclical rather than structural, and projected that the 30-year Treasury yield could rise to 6%, according to Bloomberg. A 6% yield on the 30-year note would be the highest since June 2000. Pradhan added that forecasts for where the policy rate ultimately settles need to be revised upward and that long-dated yields will move higher accordingly, signaling a greater likelihood of further Fed rate increases.
