Jerome Powell says higher bond yields are producing tighter financial conditions

Jerome Powell, Chairman of the Federal Reserve (Fed), told the Economic Club of New York that significant tightening in financial conditions with higher bond yields can have implications for the policy. Powell added that the policy setting committee is "proceeding carefully" and reiterated that they remain attentive.

Fed Chairman Powell speech key quotes

"More evidence of above-trend growth, or that labor market no longer easing, could warrant further monetary policy tightening."

"Policy stance is restrictive."

"Task of balancing too much tightening vs. too little is complicated by a rance of uncertainties."

"There may still be meaningful tightening in the pipeline."

"Committed to achieving sufficiently restrictive policy stance."

"Attentive to data showing resilience of economic growth, demand for labor."

"Lower summer inflation readings were very favorable, September data was somewhat less encouraging."

"Inflation is still too high."

"Labor market is tight but gradually cooling."

"Higher bond yields are producing tighter financial conditions, which the Fed wants."

"I don't think there's a fundamental shift in how rates affect the economy."

"Markets have been front running Fed policy changes."

"Neutral rate may have risen in near term, unclear about longer term."

"It's possible we are going into a more inflationary period, but it's hard to know."

"Bond yield rise doesn't seem to be about expectations of Fed doing more on rates."

"Not clear if bond yield rise will be persistent, markets are volatile."

Market reaction to Fed Chairman Powell speech

The benchmark 10-year US Treasury bond yield retreated to the 4.9% area with the initial reaction and the US Dollar (USD) lost strength against its major rivals. At the time of press, the USD Index was down 0.42% on the day at 106.12.

 

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This section below was published at 12:00 GMT as a preview of the Fed Chairman Powell's speech at the Economic Club of New York.

• Fed Chairman Jerome Powell will speak before the Economic Club of New York.
• Powell’s comments on monetary policy and interest rate path will be scrutinized by markets.
• The US Dollar could show significant reaction to Powell’s speech before the Fed’s blackout period begins on Saturday.

Jerome Powell, Chairman of the Federal Reserve (Fed), will deliver prepared remarks before the Economic Club of New York and respond to questions. Powell’s speech is expected to offer important clues on the Fed’s next policy step and ramp up market volatility before the Fed’s blackout period, during which policymakers are barred from speaking on the economy or policy, starts on Saturday.

The Fed decided to leave the policy rate unchanged at the range of 5.25%-5.5% after the September policy meeting, as expected. The revised Summary of Economic Projections offered a hawkish surprise by showing that the majority of policymakers saw it appropriate to raise the interest rate one more time before the end of the year. Changes in market dynamics and macroeconomic data releases since the Fed’s September policy announcements, however, made it difficult for investors to make up their minds about the Fed’s next policy step.

Growing concerns over a US debt rating downgrade amid a lack of progress in budget negotiations triggered a bond sell-off in late September and early October. In a two-week period, the benchmark 10-year US Treasury bond yield surged from 4.5% to nearly 4.9% to touch its highest level since 2007. Several Fed policymakers saw the increase in yields as a development that could allow the US central bank to keep the policy rate steady for the remainder of the year.

Philadelphia Fed President Patrick Harker said that tighter market conditions were “akin to rate hikes in impact,” while San Francisco Fed President May Daly argued that tight bond yields could be “the equivalent of another rate hike.” On the same note, "financial markets are tightening and that will do some of the work for us,” noted Fed Governor Christopher Waller. These comments attracted dovish Fed bets and the CME Group FedWatch Tool’s probability of a no change in the policy rate this year rose above 70%.

On the other hand, recent macroeconomic data releases from the US highlighted the resilience of the economy and the stubbornness of inflation, causing investors to second guess themselves about the rate outlook.  

Inflation in the US, as measured by the change in the Consumer Price Index (CPI), held steady at 3.7% on a yearly basis in September, the US Bureau of Labor Statistics reported. However, the so-called “super core inflation,” which measures the change in the prices of core services excluding the home rent component, rose 0.6% on a monthly basis. Other data showed that Nonfarm Payrolls soared by an impressive 336,000 in September, reaffirming tight labor market conditions. Finally, consumer activity remained strong, with Retail Sales and Personal Spending growing at a healthy pace in September.

When is Powell speech and how could it affect the USD?

Fed Chairman Jerome Powell is scheduled to deliver prepared remarks before the Economic Club of New York at 16:00 GMT. 

In case Powell notes that rising bond yields could allow the Fed to refrain from raising the policy rate again this year, the US Dollar (USD) could come under heavy selling pressure, with bond yields making a sharp downward correction. Such a dovish tone is likely to boost risk-sensitive equity markets.

On the other hand, Powell could deliver a hawkish message by reiterating the need to raise the interest rate one more time, citing the lack of progress in inflation and the strength of the US economy. In this scenario, the USD could continue to outperform its major rivals. 

The Fed’s chairman could also adopt a neutral tone by saying that they will have more data before the end of the year to decide whether further policy tightening will be necessary. Although the initial reaction in this case could ramp up the USD’s volatility, a decisive move in either direction could be hard to come by with investors opting to wait at least until the October jobs report data to take position. 

Economists at Société Générale share a brief preview of Powell’s speech:

“The debate whether higher rates are required appears to have been settled at least for the November meeting (pause) because of the bear steepening of the Treasury curve. Unless Fed chair Powell springs a surprise tomorrow and calls the meeting ‘live’. This may explain why the dollar is struggling to pursue its advance. Whether the greenback will hold its ground may depend on whether pricing for December FOMC surpasses 50%.”