Pricing In A US Rate Hike… Again

US Treasury yields are trending higher again, buoyed by upbeat economic news in recent days — on both sides of the Atlantic. Low inflation may persuade the Federal Reserve to delay its first round of rate hikes, but a generally positive run of macro data in recent days has refocused the bond market’s attention on the potential for tighter monetary policy later this year.

The American housing market begs to differ (this week’s release of January housing starts fell short of expectations with a mild dip vs. the previous month). Otherwise there’s still a strong case for expecting moderate growth. Industrial production rose less than forecast last month, but yesterday’s news on jobless claims advised that new filings for unemployment benefits fell more than expected and remain near historic lows. Meanwhile, the Conference Board’s US Leading Index posted a modest gain for January.

Today’s preliminary releases of February business survey data for Europe also suggest that growth may not be as precarious around the globe as previously assumed. The flash estimate of Markit’s Eurozone PMI Composite Output Index for this month ticked up to a seven-month high, and reflected job growth at the highest rate in four years.

Consider, too, that the recent deceleration in global growth reversed course last month. The JP Morgan Global Manufacturing & Services PMI reflected a slightly faster expansion in the January estimate, offering a counterpoint to recent forecasts of a slowdown in the global economy.

Stepping back and considering the recent run of numbers suggests that the crowd will trim its demand for liquidity and safety. In fact, that’s just what we’re seeing via Treasury yields lately. After trending lower through most of January, interest rates have rebounded this month. The benchmark 10-year Treasury yield rose to 2.11% yesterday (Feb. 19), a hair below the highest level so far this year.

The 2-year yield, which is considered to be highly sensitive to rate expectations, has also run higher lately as well. Rising to 0.67% yesterday, the 2-year has regained most of the slide that unfolded from late-December through January.


The market’s inflation expectations are on the march again too, albeit after months of sliding lower. For instance, the implied inflation via the yield spread for the nominal 10-year less its inflation-indexed counterpart ticked up to 1.74% yesterday, the highest since early December. That’s still quite low, but the directional change seems to have some momentum and so even higher levels may be coming in the weeks ahead.


There are, of course, caveats. Despite the upbeat numbers of late, it wouldn’t take much to puncture the optimism. An unexpected turn in the tortured negotiations between the European Union and Greece could easily change the crowd’s view. There’s also Mr. Putin’s geopolitical machinations to contend with and so it’s fair to say that Europe’s recovery, if we can call it that, may be at the mercy of the Kremlin.

But for the moment, the glass is half full… again. Yes, this week’s release of minutes for the Jan. 27-28 FOMC meeting suggest that Fed policymakers may be inclined to delay the first rate hike—as early as June, according to recent predictions. But perhaps that’s too ambitious. “Many participants observed that a premature increase in rates might damp the apparent solid recovery in real activity and labor market conditions,” the FOMC minutes advised.

The comment certainly resonates when you consider that inflation is still running well below the Fed’s 2% target—just 0.75%, based on the year-over-year change in the headline personal consumption expenditures index through December. But minds may differ on whether this alone will stay the central bank’s hand. Rate hikes certainly aren’t imminent, and June is looking like a low-probability forecast at this point. But based on recent action in the Treasury market, the potential for tighter monetary policy sometime this year is still a viable prospect.

That’s a reasonable view, and will remain so as long the labor market continues to improve at the faster pace we’ve seen in recent months. What are the odds that the next payrolls report will deliver another batch of encouraging news? Perhaps higher than you think, or so it seems based on the persistent increase in job openings. As Greg Mankiw at Harvard notes, the bullish trend in job openings “is not the picture of an economy with lots of slack.”