The yield of the 10-year U.S. Treasury, which serves as the benchmark for mortgage rates, has reached its highest level in 2023 due to mounting expectations that the Federal Reserve will maintain higher interest rates to combat inflation. On Tuesday, the yield on the 10-year Treasury surpassed 4.23%, marking its peak since November of last year and a rise from 4.02% recorded last Thursday. This surge in yield followed the release of the latest consumer price index (CPI) data, which indicated a break in the previous downward trend of inflation.
Borrowing Costs Remain Restrictive
According to Henry Allen, an analyst at Deutsche Bank, borrowing costs are becoming more restrictive in real terms. The primary driver behind the increasing yields is the belief that the Fed will maintain its restrictive monetary policy for a longer duration than previously expected. This shift in market sentiment has resulted in a more hawkish outlook for the policy path.
Inflation Concerns and Higher Treasury Yields
The latest CPI print revealed a year-on-year increase of 3.2%, raising concerns that the period of decelerating price growth has come to an end. Despite this, inflation continues to surpass the Federal Reserve's target of 2%. Consequently, Treasury yields have been steadily rising across the yield curve, leading to increased speculation among traders regarding a more aggressive stance from the Fed.
Market Expectations and FedWatch Tool Analysis
Futures markets are now pricing in a higher possibility that the Fed will maintain its current interest rates of 5.25%-5.5% for an extended period or potentially raise borrowing costs further. According to the CME FedWatch Tool, the likelihood of rates remaining at their current levels during the January, March, May, or June 2024 meetings of the Fed's monetary policy committee has increased compared to the previous week. Furthermore, the same market pricing metric suggests that the chances of a quarter-point hike by one of those meetings have nearly doubled since last week, with a 25% probability that the upper bound of rates will rise to 5.75% by January, up from a 16% likelihood.
Impact on Stocks and Mortgages
Currently, elevated Treasury yields are negatively impacting stocks and dampening risk sentiment among investors as the Dow Jones Industrial Average and S&P 500 face potential losses. However, if expectations of higher rates persist, it may also put mortgages under pressure.