Why are Yields Suddenly Moving Higher

Following the FOMC meeting last week there was a brief pause in yields but on Thursday they bolted higher and haven’t really looked back since. Why is that? Well, in the sections below we discuss our rationale for why but suffice it to say that the combination of a slightly more hawkish Fed, stickier inflation projections, and a positive outlook on growth in the fourth quarter mixed in with a traditionally seasonally bearish fourth quarter seem to be some of the ingredients for the sudden backpedaling in yields.

The question then becomes where does this backup take us? Recall the first quarter saw the 10-year yield move to a year-to-date high of 1.74% on March 31. Many analysts surmised that after the subsequent rally in the second and third quarters that that would be the high water mark for the year. Now it becomes a beacon for the current selloff to try and reach. It’s less than 20bps away at this point and seems a likely level that might get tested in the coming weeks.

How High Will Yields Go This Time?

Treasury yields have been bounding higher ever since the FOMC meeting last Wednesday. The question is why is that the case? The Fed was a tad more hawkish.  They moved a rate hike into 2022 which could be thought of as bullish, tamping down inflationary embers despite a new policy framework that implied a greater willingness to let 2+% inflation run for a bit in order to encourage growth and achieve maximum employment.


Source: Bloomberg

Instead, the somewhat more hawkish Fed has been greeted with selling in Treasuries since the meeting. Obviously something else is contributing to the price action. We think it hangs on three things: stickier inflation projections, an improved fourth quarter growth outlook, and the imminent entering of a seasonally bearish time for Treasuries.

In the post-FOMC meeting press conference Powell admitted that the inflationary impulse from the transitory factors stemming from the pandemic were larger and likely more longer-lasting than originally surmised. Indeed, the supply chain bottlenecks  and other supply disruptions don’t seem to be going away anytime soon. The more recent rebound in oil and gas prices to multi-year highs adds another element to the inflation story. Also, the fourth quarter will see the rolling off of 0.1% and 0.2% month-over-month CPI gains that will likely be replace by 0.3% and 0.4% rates. That means the 3+% year-over-year rates will likely persist well into 2022, especially with the stickier price changes.

The recent decline in delta variant cases, and little flare-up from school reopening has contributed also to a renewed belief that the fourth quarter will see a resumption of growth that stalled a bit in the third quarter. The Atlanta Fed’s GDPNow has third quarter GDP at 3.2% versus 6.6% actual in the second quarter and a 5.1% Bloomberg estimate for the fourth quarter.

Finally, the fourth quarter tends to be a seasonally tough period for Treasuries with yields typically rising into year-end as eternal hopes of a better next year start to get priced into yields. The selling over the last several days could be an attempt to get ahead of that action as the other elements mentioned above conspire to move yields higher.

Consumer Confidence Fails to Bounce, Putting Fourth Quarter Growth Projections into Question

As we mentioned above, the Treasury market has taken the Fed’s more hawkish projections along with inflation and growth expectations and established a selling trend since the FOMC meeting. One of the elements of that selling has been centered around enhanced growth expectations for the fourth quarter given the decline in virus cases in recent weeks and no noticeable flare-ups that were feared as schools reopened.


Source: Bloomberg

Funny thing though on the way back to 6% GDP growth is that consumer confidence remains underwhelming, and with two-thirds of the economy tied to the consumer that is concerning. The latest Conference Board Consumer Confidence reading for September came in at 109.3 versus an expected 115.0 and 115.2 in August. It’s the lowest confidence reading since February. The index peaked at 128.9 in June and reached as high as 137.9 pre-pandemic in 2018.

Both the present situations reading and the expectations sub-index dropped in September which doesn’t signal a rebound in consumer spending in the fourth quarter. We’ve always subscribed, however, to the notion that watch what consumers do and not so much what they say, but this absence of an uptick in confidence, combined with the University of Michigan’s sentiment plunge in August, may put a damper on growth expectations early in the fourth quarter. Consumers are often slow to see the turn in economic conditions and this may be the case here but it does bear watching as we move into October.

Agency Indications — FNMA / FHLMC Callable Rates

Maturity (yrs) 2 Year 3 Year 4 Year 5 Year 10 Year 15 Year
0.25 0.19 0.48 0.79 1.15 1.92 2.38
0.50 0.17 0.46 0.73 1.04 1.77 2.26
1.00 0.17 0.42 0.70 1.00 1.68 2.14
2.00 0.41 0.64 0.92 1.57 NA
3.00 0.87 1.50 NA
4.00 1.46 NA
5.00 1.42 NA
10.00 NA

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Published: 09/29/21 Author: Thomas R. Fitzgerald