Fed's Williams Tempers September Hike Odds as Yields Retreat 3bps

The 10-year Treasury yield fell 2.8 basis points to 4.765 percent Thursday after New York Fed President John Williams said there is no clear sign rates need to rise, easing bets on a September hike.

"There's no clear signs right now whether monetary policy currently is sufficient to make sure we bring inflation back to target in the next year or two, or whether you need to see further action to do that," Williams, a permanent voter on the rate-setting Federal Open Market Committee, said in a CNBC interview Wednesday. He added that recent inflation data had been "encouraging" but that policymakers needed a fuller picture of incoming information.

The 10-year U.S. Treasury yield had climbed to 4.818 percent Wednesday, the highest since November 2023, according to Tradeweb. In Europe, the 10-year German Bund yield fell 1.5 basis points to 3.363 percent after touching a 15-year high of 3.395 percent, while the 10-year U.K. gilt declined 4.1 basis points to 5.198 percent, down from a 19-year peak of 5.294 percent. Money markets now price a 59 percent probability of a rate hike at the Sept. 15-16 FOMC meeting, down from nearly 70 percent Wednesday, LSEG data showed. Weak ADP private payrolls figures released Wednesday also contributed to the pullback.

The repricing sets up Friday's August nonfarm payrolls report as the decisive input into the Fed's decision. Analysts polled by The Wall Street Journal forecast 53,000 jobs were created in August. The Fed has held the federal funds rate in a range of 3.5 percent to 3.75 percent since its July meeting, when three regional bank presidents — Cleveland's Beth Hammack, Minneapolis' Neel Kashkari and Dallas' Lorie Logan — dissented in favor of a quarter-point increase. Minutes from that meeting showed hawkish sentiment extended beyond the dissenters, with some officials arguing financial conditions might not be tight enough to return inflation to the Fed's 2 percent target.

Williams, who had until recently been among the Fed's most vocal defenders of holding rates steady, attributed the surge in Treasury yields to economic strength rather than market dysfunction. "What's driving it, in large part, is really a strong U.S. economy and a strong economic outlook fueled by big investments in AI and data centers and technology in general," he said, describing inflation expectations as "well anchored" despite price pressures tied to tariffs and the Iran war. In early August, he had said current policy was "well positioned" and expected inflation to cool.

Declining oil prices added another boost for bonds, with Brent crude down 1.2 percent at $94.52 a barrel, easing inflation concerns. But the selloff in bonds may not be over. "You have two stresses hitting bond markets around the globe at the same time: a structural supply problem from deficits and massive issuance rates of corporate and sovereign," said Natalia Lojevsky, managing director at CIFC Asset Management. That combination explains the recent jump in yields and why it has been relatively aggressive, she said. With governments across the developed world running large deficits and corporations tapping debt markets at record pace, the supply overhang is likely to keep upward pressure on term premiums even if the Fed holds rates steady.

The last time the 10-year Treasury yield traded near current levels was November 2023, when the Fed was still in its tightening cycle and markets were pricing further increases. The backdrop now differs: the fed funds rate has been on hold since July, and the debate has shifted to whether the central bank needs to resume hiking after a fractured vote.

Friday's payrolls data will be the key test. "When we triangulate across all the labor market data that will be released this week, we're expecting that the labor market will be room temperature, rather than boiling or frozen. And that would be good news for the Fed," said BeiChen Lin, senior investment strategist at Russell Investments. However, if job creation comes in significantly stronger than consensus expectations, "that might cause the Fed to give more consideration to rate hikes if inflation does not cooperate," he said.

This article is for informational purposes only and does not constitute investment advice.