Treasury yields have surged in recent days as investors pull back expectations for interest rate cuts later this year. The yield on the benchmark 10-year Treasury note topped 4% as central banks globally signaled further rate hikes to tame inflation.
Fed Pushes Back Against Rate Cut Hopes
After hitting a low of 3.73% on January 6th, the 10-year yield has risen back above the key 4% level this week (1, 2). Investors had bet the Federal Reserve would cut rates later this year if inflation continued to ease, but Fed officials have pushed back on expectations of rate cuts in 2023 (3).
In remarks this week, Fed Governor Christopher Waller stated “There is still a ways to go before we reach our 2% inflation goal in a sustainable manner” and that continued rate hikes would be needed (4). Other Fed officials such as James Bullard have also cast doubt on imminent rate cuts. The pushback from the Fed has led traders to adjust expectations, driving yields higher globally.
“The Fed probably has to create at least a mild recession to get inflation back down,” said Nancy Davis, founder of asset manager Quadratic Capital (5).
Economic Data Questions Rate Cut Outlook
Recent economic reports have also caused investors to second-guess bets on rate cuts. Last week’s consumer price index (CPI) showed inflation slowing less than expected in December, indicating the Fed still has work to do on inflation (6).
Additionally, last week’s retail sales data topped forecasts and jobless claims hit a nine-month low, signaling continued economic resiliency (7). This week’s robust Empire State manufacturing survey also showed an economy not yet near recession (8).
“The data suggests the Fed is going to have to do more,” said Subadra Rajappa, head of U.S. rates strategy at Societe Generale (9).
Global Central Banks Signal Further Tightening
Other major central banks have also indicated they plan to continue raising rates, supporting global yields. Last week, the European Central Bank surprised markets by signaling rates would likely rise another 50 basis points to contain high inflation in the euro zone (10).
The Bank of Canada has stated that getting inflation “back to target is our primary focus,” with further “forceful” action planned after a 25 bp hike last week (11). The Bank of England also surprised markets in December by hiking 50 bps and indicated that “further increases in interest rates may be required” (12).
| Central Bank | Recent Key Rate Decision | Outlook |
|---|---|---|
| Federal Reserve | 50 bps hike in December | No cuts in 2023, further hikes needed |
| European Central Bank | 50 bps hike in February | Rates to rise another 50 bps |
| Bank of Canada | 25 bps hike in January | Planning more “forceful” action |
| Bank of England | 50 bps hike in December | Further hikes may be needed |
This global tightening stance, along with hotter economic data, has led investors to doubt that central banks will be cutting rates this year. Markets are now pricing in rate hikes to continue through at least mid-2023 before any cuts materialize (13).
Yields Still Seen Moving Lower Over Time
While yields have rebounded lately, most analysts believe they will gradually trend lower over the long run. Inflation is still expected to continue slowly easing throughout 2023, eventually allowing central banks to reduce rates (14).
“By the second half of the year, ultimately yields and rates will come down,” said Andrzej Skiba, head of U.S. fixed income at RBC Global Asset Management (15).
Many economists also predict a mild recession by the end of 2023 that could spur rate cuts. However, central banks are likely to resist easing policy until they are confident that inflation is clearly on a path down towards their 2% target.
Overall, markets face continued volatility in the near-term as investors reassess the outlook for inflation and central bank policy. But for now, central banks seem poised to stay the course, keeping upward pressure on yields.
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