Bond yields rose yet again today even though September's PCED inflation report showed some improvement, which was due mostly to new measurement procedures. Inflation remains about a percentage point above the Fed's 2.0% target. Other economic indicators today confirmed that the economy and the labor market are doing very well and strengthened the case for more Fed rate hikes. Yesterday's dovish suggestion by NY Fed President John Williams that a pause in rate hikes might make sense was all but forgotten today.
The most optimistic explanation for the backup in bond yields is that it reflects better-than-expected economic growth, suggesting the economy's R-Star (i.e., the neutral interest rate) is higher than Fed officials thought at the beginning of the year. Back then, they mostly agreed that the federal funds rate was still slightly restrictive, i.e., above the neutral rate. Now, they agree with Fed Chair Kevin Warsh that September's 25bps rate hike "removed a dose of accommodation." That implies that the federal funds rate is below neutral.
No wonder the 2-year Treasury yield remained 100bps above the federal funds rate today (chart).
Federal funds futures are pricing in three to four 25bps rate hikes over the next 12 months, including roughly two over the next six months (chart).
