If there was any doubt that a regime of rising interest rates has arrived, the Treasury market on Wednesday dispatched a wake-up call.
The benchmark 10-year yield jumped ten basis points to 3.15% on Wednesday – the highest level since 2011 via the biggest daily increase in nearly two years. The policy sensitive 2-year rate edged higher, too, increasing to 2.85%, the highest since early 2008.
Bullish economic news is a key factor in lifting rates. Yesterday’s ADP Employment Report was surprisingly strong. Economists were expecting a gain of 179,000 jobs for September, according to Econoday.com’s consensus forecast; the actual increase is 230,000. Notably, the year-over-year trend strengthened: private payrolls rose 2.0% through last month, the strongest advance in over four years.
The ADP data strongly suggests that Labor Department’s September update on nonfarm payrolls tomorrow will deliver upbeat numbers too. If yesterday’s release is a guide, Econoday.com’s consensus forecast for a gain of 175,000 in private-sector jobs in Friday’s release looks set for an upside surprise.
Yesterday’s sentiment numbers for the US services sector added to the bullish aura, based on the ISM Non-Manufacturing Index for September. This gauge jumped to the highest level on record (albeit for a history that only dates to 2008).
“The continued strength of the [ISM data] implies that growth is set to remain well above trend,” advised Andrew Hunter, US economist for Capital Economics. “That will keep the Fed raising interest rates steadily in the near term.”
The competing Services PMI didn’t confirm the hot ISM print. Instead, the PMI dipped to an eight-month low in September. “Service sector business growth has eased considerably since peaking back in May, but remains relatively solid,” noted Chris Williamson, chief business economist at IHS Markit. “Some of the slowdown can be traced to capacity constraints, with new business once again rising at a steeper rate than firms were able to boost output.”
But for cheerleading the US economic outlook, yesterday’s remarks by Fed Chairman Jerome Powell stand out. Speaking at a conference on Wednesday (Oct. 3), he said that “there’s really no reason to think that this cycle can’t continue for quite some time, effectively indefinitely.”
Recent nowcasts of third-quarter GDP growth support the positive outlook. As reported by The Capital Spectator yesterday, the current estimate for Q3 output is 3.2%, based on the median nowcast via several sources. While that’s below Q2’s strong 4.2% rise, an expansion in the low-3% is still a healthy pace that implies that the expansion has enough forward momentum to roll on for the foreseeable future.
Fed funds futures are currently pricing in expectations that the central bank will lift interest rates again at the Dec. 19 policy meeting. As of this morning, this market is estimating an implied 78% probability of year-end rate hike of 25 basis points in the Fed’s target rate to a 2.25%-3.0% range, according to CME data.
The question is whether the rising trend in interest rates will endure? The current upswing has been in force for more than two years, dating from the summer of 2016, when the 10-year yield briefly dipped below 1.40%.
Skeptics will note that we’ve been here before. From mid-2012 through January 2014, the 10-year rate trended up before hitting a ceiling, followed by a slide over the subsequent two years.
The difference this time is that economic momentum is stronger. Is that a difference that keeps interest rates trending higher for longer? It’s reasonable to think so, assuming that the incoming data doesn’t hit an air pocket.
“Solid data releases, higher oil prices and a technical backdrop that suggests there are not a lot of obstacles for yields to continue to push higher will have many wondering how far this new push higher can go,” says Rodrigo Catril, a strategist at National Australia Bank in Sydney.
For the near term, expecting Treasury yields to hold steady or rise further strikes some analysts as a reasonable bet.
“You’ve had a confluence of strong fundamentals as well as a breakdown in key technical levels,” notes Nils Overdahl, a senior portfolio manager at New Century Advisors. “When these technical levels are broken you don’t want to try and catch the falling knife [as it relates to falling bond prices, which move inversely to yields]. You have to feel comfortable you’ve seen some capitulation before you step in.”