Surging Yields Mean Fed is Unlikely to Hike in November

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Stocks and bonds fell on Thursday following a 30-year Treasury auction that saw limited demand, resulting in a surge in yields. Moreover, the consumer price index (CPI) report for September exceeded analyst expectations, fueling bets that the Federal Reserve may be forced to deliver another rate hike in 2023

The tepid response to the 30-year bond auction added to existing downward pressure on both equities and Treasuries. The dollar strengthened, while precious metals, which lack interest-bearing qualities, fell on the back of the rising yields.

Sticky Inflation is a Big Headache for the Fed

The headline CPI print rose by 3.7%, surpassing analyst expectations for an annual growth of 3.6%. According to the U.S. Bureau of Labor Statistics (BLS), the CPI rose 0.4% in September on a seasonally adjusted basis, after increasing 0.6% in August. Analysts were looking for a month-over-month jump of 0.3%.

While the slowdown on a MoM basis is noticeable, consumer prices for a wide range of goods and services still rose slightly faster than anticipated, keeping inflation in the forefront for policymakers.

Excluding the more volatile food and energy prices, the so-called core CPI increased by 0.3% for the month and 4.1% over a 12-month period, both in line with expectations. Policymakers place greater emphasis on the core figures as they tend to be more reliable indicators of long-term trends.

Core inflation also rose by 0.3% in August, when it was up 4.3% over the previous 12 months.

“Just because the rate of inflation is stable for now doesn’t mean its weight isn’t increasing every month on family budgets,” said Robert Frick, corporate economist with Navy Federal Credit Union. “That shelter and food costs rose particularly is especially painful.”

The index for shelter, which carries significant weight in the CPI, accelerated by 0.6% for the month and 7.2% from a year ago. Monthly, shelter accounted for over half of the CPI’s increase, according to the Labor Department.

Energy costs increased by 1.5%, driven by a 2.1% rise in gasoline prices and an 8.5% increase in fuel oil costs. Food prices saw a 0.2% increase for the third consecutive month. Over a 12-month period, food costs rose by 3.7%, including a 6% increase for food consumed away from home, while energy costs decreased by 0.5%.

Services prices, which are considered important for predicting longer-term inflation trends, also posted a 0.6% gain, excluding energy services, and increased by 5.7% over a 12-month period. Vehicle prices were mixed, with new vehicles rising by 0.3% and used vehicles declining by 2.5%. Used vehicle prices, which were a significant driver of inflation during the early days of the COVID pandemic, decreased by 8% from a year ago.

Fed to Hold Again in November

The hotter-than-expected September CPI report comes at a delicate moment for the Fed after minutes from the central bank’s September meeting showed divisions within the rate-setting Federal Open Market Committee (FOMC), which is due to communicate its next monetary policy decision on November 1.

While the committee decided not to raise interest rates at the September meeting, the minutes indicated persistent concerns regarding inflation and the presence of potential upside risks.

Market expectations also imply that the Fed will reduce its key lending rate by approximately 0.75 percentage points before the conclusion of 2024. According to the Fed Rate Monitor Tool, the market is currently pricing in a 9% probability that the Fed will hike in November. However, the chances for a December hike rose from 28% to 34%.

“Overall, there is probably not enough in the report alone to suggest to the FOMC that it needs to be tightening policy again in November, but it will see it as justifying its message that policy needs to remain ‘tighter for longer,’ with the prospect of another rate rise still being kept on the table,” said Stuart Cole, chief macro economist, at Equiti Capital.

Analysts argued that the Fed was almost certainly set to stay on the sidelines if inflation came in line with expectations or below what the market was expecting. Despite the sticky inflation, one of the key reasons why the Fed is expected to hold rates at current levels is due to a sudden and unexpected surge in bond yields.

Prominent central bank officials have recently indicated that they might refrain from further increases in short-term interest rates as long as long-term rates remain close to their recent highs.

“If long-term interest rates remain elevated because of higher term premiums, there may be less need to raise the fed-funds rate,” said Dallas Fed President Lorie Logan, a voting member of the Fed’s rate-setting committee, said on Monday.

In July, the Fed raised its benchmark federal funds rate to a range of 5.25% to 5.5%, marking a 22-year high. During their last meeting, officials opted to keep rates unchanged and suggested that they were still planning to raise rates at one of their remaining two meetings this year.

The Fed increases interest rates as a strategy to combat inflation by slowing down economic activity. When interest rates rise, borrowing becomes more expensive, which can lead to reduced investment and spending. This effect is amplified when the higher rates also put downward pressure on stock and other asset prices.

Hence, if the 10-year Treasury yields continue to rise to levels not seen since 2007, these increases could potentially serve as a substitute for additional hikes in the federal funds rate by achieving similar economic tightening effects.

Markets were also spooked by a very weak bond auction on Thursday, an indication of a poor investor appetite for long-duration bonds. The recent U.S. Treasury 30-year bond auction resulted in a higher yield of 4.837%, which was 3.7 basis points above the expected rate at the bid deadline.

In other words, investors demanded a premium to purchase the long-term bond. The bid-to-cover ratio for this auction was 2.35, which was lower than the previous month’s ratio of 2.46 and the 2.39 average. This auction followed a series of weak sales of 10-year and three-year notes earlier in the week.

“It was the third consecutive auction this week that tailed, that showed some weakness, reinforcing the yields’ upward momentum,” said Will Compernolle, macro strategist at FHN Financial in New York.


U.S. Treasury yields rose on Thursday due to higher-than-expected inflation figures for September raising the possibility that the Fed might enact another interest rate increase later this year. Moreover, poor demand in a 30-year bond auction contributed to the increase in Treasury yields. This way, the higher bond yields are likely to allow the Fed not to hike at its upcoming meeting in November.