In the two weeks since the Federal Reserve’s September policy meeting, yields on 10-year US Treasuries have climbed more than 50 basis points, topping out at nearly 4.9%. Almost every day, there’s a new “highest since 2007” type of headline in the bond market. So, what’s driving the moves?
Chicago Fed President Austan Goolsbee, in a new episode of the Odd Lots podcast, says the timing of the selloff is something of a “puzzle.”
The quarterly Summary of Economic Projections the Fed released after the meeting “was a little different than the previous SEP, but was it so different that it would lead to a material change in a three-week period? That part’s still a puzzle,” he said.
“I think the puzzle that people are trying to put together is, well, why did it happen in the last three weeks?” he said. “But if you take a six-month perspective, in a way, I don't think it's that much of a puzzle — it's clear that the long rates coming up is what you'd expect.”
The projections showed Fed officials now see only 50 basis points of rate cuts next year — down from 100 previously — but why that would produce such a dramatic move at the long end of the yield curve has caused even many on Wall Street to scratch their heads.
That move has rekindled worries over the potential for something to “break” in the financial system. Memories of Silicon Valley Bank, which experienced a run on its deposits in March after taking a big hit on its bond portfolio, are still fresh. Tighter financial conditions could also bring about a larger-than-intended slowdown in the economy.
“We absolutely monitor that and are thinking about that, and that could be a blow to either the financial or the real economy,” Goolsbee said. “If there is a credit crunch — if those things materially deteriorate in a way that we haven't seen, but feared seeing, over the last six months — we will adjust, and we’ve got to think about it. By law, we have a dual mandate.”
Still, the Chicago Fed chief remains optimistic that the central bank can continue down what he calls the “golden path” to the “mother of all soft landings.” Over the last year or so, inflation has receded dramatically even as the unemployment rate has stayed below 4%. And while inflation hasn’t returned to the Fed’s 2% target yet, the most recent readings have been highly encouraging.
“We’ve been making quite substantial progress on getting the inflation rate back down to where we want it,” Goolsbee said. “And for all of the attention and heat about whether inflation would stall out at 3.5% or 3%, I would just point out: If you take the three-month performance of inflation, we already blew through 3%. We’re already getting it down more.”
Goolsbee credits ongoing supply-chain healing for most of the improvement, and indexes of supply-chain stress suggest there’s still more disinflation to come from that channel. He also sees the Fed’s rate hikes as having played a crucial role in keeping inflation expectations — both survey measures and also market-based measures — in check. On top of the supply-chain progress, the job-market picture has stabilized thanks to rising levels of labor force participation and a return to historical immigration norms, he said.
Even so, Goolsbee urged market participants to believe the central bank when it says it’s going to do what it takes to bring inflation back down to 2%, citing Silicon Valley Bank as a cautionary tale.
“Remember the lesson of Silicon Valley Bank,” he said. “Silicon Valley Bank knew they don’t have a traditional deposit franchise — and they knew they hold a bunch of bonds and that the rates are going up — so I could not for the life of me understand, why didn’t they just hedge?”
“They did hedge, but then they thought that the Fed wouldn’t stick it out and that they would make more money if they got rid of the hedges, and so they got rid of them. And that’s yet another in the long line of lessons: Don’t bet against the Fed. That’s not a good idea.”