Fed highlights economic strength but muddies outlook for Treasuries
TLT•The Fed held interest rates steady while upgrading its assessment of the U.S. economy to “strong,” leaving bond investors uncertain about inflation and future policy. The Treasury yield curve steepened after the decision, and markets priced in the possibility of another rate increase in December.
1. Bond yields climb
The Federal Reserve kept interest rates steady on Wednesday, but its assessment of a strong economy and persistent inflation left bond investors uncertain about the path of policy and longer-term Treasury borrowing costs. The yield curve steepened after Fed Chair Kevin Warsh’s press conference, with the spread between 2- and 10-year yields widening to as much as 34.1 basis points.
2. Inflation and fiscal concerns
The Fed upgraded its description of economic activity to “strong” from “solid” at its September meeting, citing robust investment and job gains keeping pace with the workforce. Investors are weighing the risk that resilient growth and persistent inflation could limit future rate cuts, while concerns about the fiscal outlook and government borrowing needs could raise the compensation demanded for holding longer-dated bonds. Markets are pricing in the possibility of another rate increase in December.
3. Doubts about growth
Some market participants questioned the Fed’s assessment, pointing to slowing payroll trends and a cooling Atlanta Fed GDPNow forecast. Citigroup chief U.S. economist Andrew Hollenhorst said Warsh was “overstating the breadth of strength in the US economy,” which could leave the Fed with a relatively low bar for a downside surprise.
