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Will lower US yields prompt a hawkish shift from the Fed?
Overnight, the foreign exchange rates have found stability, with EUR/USD hovering just above the 1.066 level and USD/JPY slightly above the 151.00 mark. The significant market development from the previous day was the ongoing decline in the oil market, where the Brent crude price dropped below USD 80 per barrel. This downturn has influenced market-based indicators of inflation expectations, causing a decrease. The U.S. 10-year break-even rate, which was just below 2.50% on October 19th, has now settled around 2.35%. During the same period, the 10-year U.S. Treasury yield has decreased by approximately 0.50 points from slightly above 5.00%, currently testing support at 4.50%.
The initial surge in oil prices triggered by the Hamas-Israel conflict has proven short-lived, reinforcing the belief that inflation will continue to decelerate in the coming year. This supports the expectation that the Federal Reserve is unlikely to further raise rates and may begin to reverse rate hikes next year due to slower inflation and growth. Following the release of the weaker non-farm payrolls report for October, the U.S. rate market is more confident in pricing in additional rate cuts from the Fed by the end of next year. Approximately 88 basis points of cuts are currently priced by December 2024, mirroring expectations from the European Central Bank over the same period.
Despite the recent resilience of the U.S. economy compared to the euro-zone, U.S. rate cut expectations appear more aggressive than those for the ECB. For the U.S. rate market to anticipate even deeper rate cuts, the U.S. economy would need to significantly slow in the coming quarters, and/or inflation would need to fall more rapidly than anticipated. This outlook should help prevent a more pronounced sell-off of the U.S. dollar in the short term, casting doubt on the sustainability of last week's sharp sell-off.
The pullback in U.S. yields has raised questions about whether the Fed will need to raise rates further if market yields continue to decline. Despite a 0.50-point drop from the recent peak, the 10-year U.S. Treasury yield remains well above levels seen before the summer, when it averaged just over 3.8% between June and July and just over 3.6% in the first half of this year. Financial conditions, even after the recent pullback in U.S. yields, still exert significant pressure, alleviating the Fed's need to further raise rates in response to the robust growth in Q3.
However, it's worth noting that Powell has already spoken today at the Monetary Policy Discussion Panel (you can watch it on this link:
) and indicated that he does not believe the rates are at sufficiently in restrictive levels yet. This has impacted a bullish momentum on yields and the U.S. dollar. In my opinion, I still anticipate a pause for December, as the CME FEDWatch Tool hasn't changed much after Powell's speech today, as we can see only 14% are expecting a hike in 13/12/2023.FEDWatch Tool
Source: CME
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