Falling Treasury yields have led to a rebound in stocks and lifted U.S. government bonds from their lows. However, some investors are concerned that further declines in yields could keep the Federal Reserve in a hawkish stance for a longer period, potentially impacting asset prices in the long run.
The relationship between yields and financial conditions has become a focal point in recent months. Surging Treasury yields tightened financial conditions, raising borrowing costs for companies and households and dampening investor risk appetite.
In recent weeks, this relationship has reversed. As U.S. 10-year yields have fallen, the S&P 500 has rebounded. However, some investors worry that if yields continue to decline, financial conditions could become too loose, forcing the Fed to keep rates higher for longer to prevent inflation from rebounding.
Last week, the Goldman Sachs Financial Conditions Index declined as the benchmark Treasury 10-year yield reached a low point. Average rates on 30-year mortgages, which move with Treasury yields, also fell significantly.
According to Brian Jacobsen, chief economist at Annex Wealth Management, the Fed may not want the 10-year Treasury yield to go below 4.5% or above 5%. He believes the Fed’s stance will adjust with rates to maintain a specific range.
Jacobsen remains bullish on bonds, predicting that the Fed will keep rates elevated for too long, leading to an economic recession.
Some Fed officials have suggested that rising yields could substitute for further rate hikes by tightening financial conditions.
Analysts at TD Securities believe that further easing in Treasury yields will eventually have both positive and negative effects. If the market perceives the Fed as dovish, financial conditions will ease, prompting a more hawkish stance from the central bank.
Futures markets are now pricing in a high chance of the Fed holding rates steady at its December meeting and anticipating rate cuts in May 2024.
The S&P 500 has continued its streak of positive gains, reaching its eighth straight close in the green.
Other factors, such as declining oil prices, are also contributing to the easing in financial conditions.
If Treasury yields continue to fall in the context of a slowing economy, the Fed may view it as confirmation of their plan to control growth.
Investors are monitoring upcoming U.S. consumer price data, which is expected to show a slight monthly rise for October.
Samana, senior global market strategist at the Wells Fargo Investment Institute, is buying longer-duration bonds and expects yields to settle in the low 4% range as the economy weakens.
Overall, the Fed’s stance on rates will depend on various factors, including the trajectory of Treasury yields and economic indicators.
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