Why Fed Rate Hike Not Boosting Yields

Contrary to conventional wisdom, the Fed’s rate hike has seen Treasury yields drop.

Reviewed by: Cinthia Murphy
Edited by: Cinthia Murphy

The Federal Reserve may be on a path to raise interest rates, but Treasury yields, so far, have bucked the trend and declined since the Fed’s first rate hike in December.

Pressure All Along The Curve

If the recent trajectory in yields is somewhat surprising, what’s also interesting is the fact that the downward pressure on yields has been felt across the curve—even in the shorter end, where Fed action is a key driver.

Conventional wisdom is that 10- and 30-year yields are more influenced by macro factors and the economy, whereas two-year and shorter yields are more influenced by the Fed.

But the chart below plots two- and 10-year yields since Dec. 16, when the Fed announced its first rate hike in nearly seven years:

“The two-year Treasury yield has fallen recently because the market is adjusting its expectations of future Fed hikes,” said Anthony Parish of Sage Advisors.

“Recent economic data in the U.S. and around the globe suggest the Fed will have to moderate its hawkish tone,” Parish added. “This translates to a more gradual pace of rate hikes, and possibly a lower neutral fed funds rate. The Fed worrywarts just took a chill-pill.”

Global Concerns Grow

A look at ETF asset flows corroborates the notion that investors are concerned about the global economy, and the U.S. going forward. There’s plenty of talk in the market today about a possible recession here this year.

In January, investors poured more than $13 billion into U.S.-listed fixed-income ETFs—money that landed primarily into U.S. Treasury funds in a typical case of flight-to-safety. In fact, that demand ranged from short-dated funds, such as the iShares Short Treasury Bond (SHV | A-97), to the long-dated iShares 20+ Year Treasury Bond (TLT | A-83), as well as for safe-haven assets such as gold.

January saw the S&P 500 Index slip more than 100 points, or roughly 5%, amid volatile action.

Oil Also Weighing On Yields

Another crucial factor fueling that demand is what’s happening in the oil market. As oil prices continue to decline, the market has been faced with increased volatility, according to Nannette Sabo, vice president and portfolio manager of fixed income at Cumberland Advisors.

“The Fed did move to raise rates in December; however, global economic challenges and uncertainties with oil continue to fuel a flight-to-quality and interest in the Treasury markets,” she said.

“We are seeing interest and strong rallies along all tenors of the yield curve most expressed in the longer end, but certainly not absent from the shorter tenors too,” added Sabo. “The volatilities in oil have hit many by surprise and have compounded the global concerns.”

And by all indications, going forward, that flight-to-quality centered on global economic concerns and oil price weakness should continue to weigh on yields.

Contact Cinthia Murphy at [email protected].

Cinthia Murphy is head of digital experience, advocating for the user in all that etf.com does. She previously served as managing editor and writer for etf.com, specializing in ETF content and multimedia. Cinthia’s experience includes time at Dow Jones and former BridgeNews, covering commodity futures markets in Chicago and Brazil equities in Sao Paulo. She has a bachelor’s degree in journalism from the University of Missouri-Columbia.