Hot U.S. economy pushes real yields to around 15-year highs after Powell’s Jackson Hole speech

Taken together, the moves telegraphed the market’s view that the Fed isn’t likely done with lifting interest rates and that the underlying U.S. economy remains hot. The TIPS rate reflects how the economy is likely to perform when inflation isn’t a factor, and right now is showing stronger prospects beyond the next few years.

Read: Rise in Treasury yields is almost entirely due to one factor, strategist says

Considering the Atlanta Fed’s GDPNow forecasting model is pointing to a 5.9% growth rate for real gross domestic product in the third quarter, “even if it’s half of that, the economy is still accelerating,” said Marc Chandler, chief market strategist at Bannockburn Global Forex in New York. The world’s largest economy grew at a solid 2% pace in the first quarter, followed by a 2.4% pace for the second quarter.

The “market went into Powell’s speech thinking he was a dove, with stocks higher and the dollar softer,” Chandler said in a phone interview. It was only after he was done that “markets reverted to taking stocks down and the dollar higher” as Treasury yields climbed, he said. Equities then reversed course again, with all three major indexes
DJIA

SPX

COMP
heading higher again as of Friday afternoon.

One- through 7-year Treasury yields were also up, with the 2-year Treasury note underperforming and its corresponding yield rising by as much as 9.4 basis points, as traders and investors focused on the more hawkish aspects of Powell’s remarks.

The Fed chairman said that policy makers are prepared to raise interest rates further if appropriate and inflation remains too high. He also said policy makers will proceed carefully as they assess the incoming data, and “restrictive policy will likely play an increasing role” in getting inflation back down to the Fed’s 2% target.

Mike Sanders, head of fixed income at Madison Investments in Madison, Wis., which oversees more than $20 billion in assets, said “there is some concern about stronger recent economic activity which could keep inflation higher.”

“We view the speech as slightly hawkish,” he wrote in an email to MarketWatch. “With recent data pointing towards better-than-expected economic growth, we believe risks are slightly higher towards an additional hike.”

Indeed, the market-implied chances that policy makers will lift the fed funds rate target in November or December — to between 5.5%-5.75% — crept up slightly after Powell’s remarks. As of Friday afternoon, the 10-year rate was little changed at 4.28%. Twenty- and 30-year Treasury yields were down, as traders weighed the most likely long-term impact of the Fed chairman’s remarks.

Powell presented “a lot of familiar themes,” said Will Compernolle, a macro strategist at FHN Financial in New York. But what matters more is “the point of emphasis,” and Powell is looking at the momentum in super-core inflation “as horizontal, with little signs of improvement once all the noise zeroes out.”

“The economy was kicked, didn’t fall down, and is showing signs that it’s reaccelerating. The economy is not only hot, but potentially growing even faster,” he said via phone. Given the Fed’s long-run expectations for growth to be around 1.8%, anything higher than that “will encourage the Fed to tighten more and give policy makers a little more license to tighten because the economy is not tipping into a recession.”