Treasury Yields Rise as “Fear Factors” Subside, Fed to Unveil Balance Sheet Strategy

Last Friday, the 10 year T yield dropped to 2.01% on a huge “risk off” trade.  Today the 10 year T closed at 2.19%.  Why?  Investor fears have subsided due to: (1) Hurricane Irma damage (while very serious) was less than anticipated as the storm’s path avoided the heart of Miami-Dade and it weakened as it moved inland; (2) North Korea did not provoke hostilities (no missile launches, etc.) on it’s anniversary over the weekend; (3) Weekend chatter in Washington in the wake of the debt ceiling deal turned to further cooperation on tax reform.  This week’s economic reports included an all-time high in median household income (but disparities are increasing) and an increase in PPI (but less than expected and the increase was partially driven by a spike in energy costs due to Hurricane Harvey’s effect on the sector).  On the Fed front, it looks like there is only one more opportunity to raise rates this year and that will come in the December meeting.  There are only two meetings remaining that will be accompanied by a press conference by Fed Chair Yellen (September and December).  Next weeks’ meeting is expected to feature an unprecedented announcement whose effects cannot be easily predicted: the beginning of the Fed’s balance sheet reduction.  The press conference and it’s aftermath will be closely watched.  The reduction will increase the supply of Treasuries in the private sector.  The move has been telegraphed since early this year in the hopes of avoiding a 2013 style “Taper tantrum” that led to major volatility in treasuries. Market reaction could influence the Fed’s rate decision in December.  As of now, the futures market is slightly weighted toward no change in rates, but it is very close.  Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners