What happens to yields after the Fed? Three scenarios
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U.S. 10-Year Treasury yield edges up to ~3.64%
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WHAT HAPPENS TO YIELDS AFTER THE FED? THREE SCENARIOS
U.S. Treasury yields and the U.S. dollar may rise if the Federal Reserve cuts rates by 25 basis points at the conclusion of its two-day meeting on Wednesday, with only a 50 basis point rate reduction likely to send yields and the greenback lower, according to rates and forex strategists at TD Securities.
In the most dovish scenario, the Fed cuts rates by 50 basis points and notes better balance in its dual mandate of inflation and employment. It also sees further downside risks for the labor market, which leaves additional 50 basis point cuts on the table.
The bank assigns a 40% probability to this outcome, in which Fed Chair Jerome Powell also cites the increasing risk of keeping policy overly restrictive. He argues that the deeper cut is not due to deteriorating economic conditions but comes from the need to reach the neutral rate at a more rapid pace.
Here TD sees 10-year Treasury yields as likely to decline by 8 basis points, the dollar index likely to drop by 0.50% and the yield curve between five-year notes and 30-year bonds to steepen by 6 basis points.
TD's base case, which it assigns a 50% probability, is a 25 basis point cut and an indication that further cuts are coming, which could be front loaded if warranted. The statement will more explicitly note the increasing downside risks to the labor market. Powell will also adopt a dovish tone and show increasingly willingness to respond to further weakening in the labor market.
In this scenario TD expects 10-year yields to rise by 5 basis points, the 5/30 yield curve to flatten by 4 basis points and the dollar index to gain 0.40%.
A hawkish surprise, which TD assigns only a 10% probability, is that the Fed cuts rates by 25 basis points but also notes that inflation remains somewhat elevated. Powell would describe a solid economy and a still healthy U.S. consumer. He would further indicate that Fed officials want to be sure that inflation “has clearly turned the corner before fully committing to more rapid policy easing.”
In this event, TD sees 10-year yields rising 12 basis points, the 5/30 yield curve flattening by 10 basis points and the dollar gaining 0.90%.
(Karen Brettell)
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FOR TUESDAY'S EARLIER LIVE MARKETS POSTS:
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EUROPEAN CYCLICALS READY TO REBOUND - MORGAN STANLEY - CLICK HERE
EUROPEAN BANKS CHEAP ENOUGH TO ABSORB RATE CUTS - UBS - CLICK HERE
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