Bond Report: U.S. 10-year Treasury yield rises to highest since Jan. 2020 ahead of Fed meeting

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U.S. Treasury yields rose early Wednesday ahead of the Federal Reserve’s policy update, where the U.S. central bank may comment on the sharp rise in longer term yields in the past month.

What are Treasurys doing?

The 10-year Treasury note yield
TMUBMUSD10Y,
1.662%

climbed 4.8 basis points to 1.671%, its highest levels since Jan. 2020, while the 2-year note rate
TMUBMUSD02Y,
0.157%

was up 0.6 basis point to 0.157%. The 30-year bond yield
TMUBMUSD30Y,
2.410%

rose 3.3 basis points to 2.424%, around its highest since November 2019. Bond prices move inversely to yields.

What’s driving Treasurys?

The Fed will release its policy statement and updated economic projections later Wednesday, including the so-called dot plot that shows where members of the Fed’s rate-setting committee forecast its policy interest rate will be in the future.

Investors will watch to see if policymakers include the effects of Joe Biden’s $1.9trn stimulus in their economic projections.

Since the Fed last released forecasts in December, the yield on ten-year Treasury bonds has risen by about 0.7 percentage points as investors have priced in higher interest rates and inflation.

Analysts say some of the forecasts from senior Fed officials could move closer to the market’s hawkish pricing. Traders are pricing in one hike to the fed funds rate next year, even as the previous dot plot has signaled a rate increase was more likely in 2024.

Regardless, Fed Chairman Jerome Powell is expected to stick to its previous dovish messaging that the economy was far away from reaching its employment and inflation goals and there was no need to change policy yet.

However, the Fed may also decide to marginally raise the interest rate it pays banks on their cash balances, in order to thwart a downward drift of overnight interest rates within its target range of 0-0.25%. The effective federal funds rate is currently 0.07% thanks to the Fed’s monthly asset buying program which has added hugely to cash in the banking system.

Another area of concern for banks is whether the Fed will comment on the need for changes to the status of the Supplemental Liquidity Ratio, or SLR, and whether banks will be granted relief in the form of an extension to the leverage ratio when it expires on March 31. The SLR ratio was eliminated a year ago to give banks the capacity to expand their balance sheets during the coronavirus pandemic to absorb the trillions of dollars in reserves and excess deposits that the Fed created with its monthly asset buying program.

Read: What would cause the Fed to take a U-turn? Hint: a lot more than some high inflation readings

In U.S. data Wednesday, housing starts ran at an annualized pace of 1.42 million, a drop of over 10% in February. Building permits saw a similar drop to a 1.68 million pace.

What did market participants say?

“We expect the FOMC policy to focus on the implications of the pandemic and for the dots to show a rate hike is possible in 2023. They will hold off on any tapering,” said Tom di Galoma, managing director of Treasurys trading at Seaport Global Securities.

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