Bond yields have recently soared to their highest levels in over ten years, impacting borrowers and the stock market. While pinpointing the exact causes behind this rise can be challenging, a list of four key factors has been compiled by top strategists.
On Monday, the 10-year Treasury yield jumped to 4.336%, reaching its highest level since 2007. Additionally, it is on track to achieve its largest monthly increase since February. Likewise, the 30-year yield, currently at 4.457%, rose to its highest level since 2011 and saw its most significant monthly increase since October, according to Dow Jones Market Data.
One prominent driver of this surge is the expected prolongation of higher interest rates by the Federal Reserve. Minutes from the central bank’s July meeting revealed that most officials perceive “significant upside risks to inflation,” which might necessitate further rate hikes. Furthermore, the CME FedWatch Tool indicates a 10% rise in investors anticipating an interest rate hike by year-end compared to a month ago.
According to David Rosenberg, economist and president of Rosenberg Research & Associates, “The answer is…the Fed. The back end of the curve has bought into the central bank’s very hawkish tone of late.”
The Fed’s Effort to Reduce its Balance Sheet Impacting Interest Rates
The Federal Reserve’s ongoing efforts to reduce its balance sheet are playing a significant role in interest rate fluctuations. With a goal of reducing its Treasury and agency debt holdings by $95 billion per month, the Fed has struggled to meet this target so far. However, last week saw a substantial reduction of $62.5 billion, marking the largest weekly decrease since early April. As a result, the Fed’s balance now stands at $8.146 trillion, the lowest it has been since July 7, 2021.
DataTrek Research co-founder Nicholas Colas emphasized the impact of this reduction, stating that previous instances of exceptional balance sheet decreases had not influenced yields significantly. However, last week’s sizable drop seems to have made a more pronounced impact.
Weak Loan Growth: A Contributing Factor
Another factor affecting interest rates is the weakness in loan growth. When banks become less willing to extend credit or when loan demand decreases, this reduction in lending can have a similar effect on interest rates as an increase by the Fed. Recent data released on Friday revealed that small banks experienced a minimal loan growth rate of 1.9% as of August 9, adjusted for seasonal variations. This rate is the lowest it has been in nearly 12 years. Furthermore, banks across the nation have been experiencing negative year-over-year loan growth rates since mid-July.
Economic Data: Fuel for Rate Increases
Strategists have also identified economic data as a contributing factor to interest rate adjustments. Weekly jobless claims, for instance, stood at 239,000 last week, indicating continued strength in the economy. Additionally, the second-quarter GDP grew by 2.4%, surpassing expectations. Taken collectively, such data provides further justification for the Fed to continue raising rates.
By considering these various factors – the Fed’s balance sheet reduction, weak loan growth, and positive economic data – it becomes evident that multiple elements are influencing interest rate fluctuations. As the Fed navigates these dynamics, it will be crucial to monitor how these factors evolve and the potential effects they may have on interest rates going forward.
Economic Momentum Remains Strong in the U.S.
According to analysis provided by Tom Essaye from Sevens Report Research, there is currently no indication of the U.S. economy losing steam. In fact, an ideal scenario would involve jobless claims gradually declining to approximately 300k, which would help alleviate some of the upward pressure on Treasury yields.