Rates Spark: Fed Set to Keep Pressure on Amid Consumers' Confidence and Upward Yield Trend

Rates Spark: The Fed set to keep the pressure on

A key driver of market rates of late has not been the projection for the July FOMC meeting, but rather the projection for where the Fed gets to at the end of the rate cutting cycle to come. The market has been busy pricing out future rate cuts as a reflection of residual macro robustness. That's helping to elevate long dated rates, and we expect that to continue.

 

Consumers show confidence and yields head higher

In the US, a lot of the macro oomph that was seen through much of the June data is continuing to show up in the July readings. A case in point was yesterday's consumer confidence number. It had been slipping through to May, and looked at that point that it could easily lurch lower. But from around 102 (vs a reference of 100), it popped up to 110 for June, and then to 117 for July. That's now running at 17% above average, which is remarkable for an economy that is being (apparently) battered by higher interest rates, high inflation and a weak international backdrop.

 

These types of data keep the pressure on the Federal Reserve to maintain a hawkish tilt to policy. Yes, the manufacturing PMI and other survey evidence points to a recessionary tendency in the US ahead. But at the same time such warning flags have been flying for over a year now, and here we are with the consumer seemingly getting more optimistic. We doubt very much that this lasts, as the headwinds of tighter financial conditions should ultimately bite harder than currently being seen. Similarly, the tightening in financial conditions seen in Europe is having a significant dampening effect on the takedown of credit, as the latest ECB survey shows.

 

That said, we continue to identify net upward pressure on market rates in the immediate few weeks ahead. We note that the Jan 2025 fed funds implied rate is only just under 4%. This was closer to 3% when Silicon Valley Bank went down. That paved a route, at the time, for the 10yr Treasury yield to trend in the same direction – towards 3%. But not, that route is being obstructed by a markedly lower rate cut discount for the Federal Reserve through 2024 and into 2025. For that reason, and despite the macro headwinds ahead, we continue to remain positive for the US 10yr Treasury yield to head back up to a 4% handle.

 

Auctions have been heavy as interest has been drying up in Treasuries

Yesterday's 5yr auction in the US tailed, meaning that the yield at auction was higher than the market yield at the point of issue. And this was at a point where market yields were on the rise. Typically tailed auctions happen when yields are falling, or when there is underwhelming demand. The latter was applicable to yesterday's auction. The bond was well covered and had a reasonable indirect bid (often representing players like central banks). But it just was not that firm in terms of overall tone.

The 2yr auction on the previous day was also well covered, but it took the highest yield since 2007 at auction to get the paper away. Flows in previous week had been high on long duration and quite impressive. But flows in the past week or two have been less impressive. If this continues, market yields will likely continue their drift higher. We have a 7yr auction today. The good thing is its not in as rich a spot of the curve as the 5yr is. But it's still below the 2yr yield, and requires a bit of an appetite for duration.

 

Today's events and market views

The big event today is the Federal Open Market Committee outcome, from which a 25bp hike looks to be virtually guaranteed (as a zero or 50bp hike is quite unlikely). A 25bp hike is 97% priced in, so that is what the Federal Reserve is likely to deliver. The question is what Chair Powell will say, and ahead of that, the tone from the FOMC statement. In all probability that tone and Chair Powell's phraseology will be hawkish. He has little to gain from showing even a smidgen of reduced hawkishness. The Fed will feel they need to keep the pressure on, and especially during a period that has been as risk-on as we've seen of late. In the eurozone we have to wait till Thursday for the European Central Bank decision (should be a 25bp hike), while no change is expected from the Bank of Japan at this juncture. More on that tomorrow.