Concerns Over Neutral-Rate Impact on Treasury Yields
Neutral-Rate Concerns May Keep Treasury Yields High
Analysis by Ven Ram, Bloomberg Cross-Asset Strategist
Enduring High Treasury Yields
According to Neel Kashkari, the short-run neutral rate might cause the back end of the Treasury yield curve to remain high for an extended period. The Core PCE has averaged 2.9% this year, which is above the 2.6% estimated by the Fed in its March dot plot, which was already an upward revision. Despite softer than expected April jobs data, the average unemployment rate this year is only 3.8%, significantly below the level the Fed believes is necessary to rebalance the labor market.
Kashkari's Perspective
In his most recent essay on the Fed Minneapolis website, Kashkari stated that the policy committee "has more work to do" if inflation is to stabilize at around 3%. He has also suggested a higher short-run neutral rate. The neutral rate, indicative of a fully employed economy with steady inflation, is still high at 1.12%, according to the latest update of the Laubach-Williams model.
Comparing with Fed's Assumption
This contrasts with the Fed's implicit assumption of a 60-basis point real neutral rate, based on its March summary of economic projections. If the Core PCE were to hover around 3%, as Kashkari fears, and assuming the Laubach-Williams model provides a more realistic reading of the real neutral rate, the implied nominal policy rate would be over 4%, making the current rate less restrictive.
Possible Interest Rate Hike
Kashkari has suggested that there is a chance of interest rates needing to increase, although he clarified that this is not the most likely scenario. He also does not have a vote on monetary policy this year. However, even if this prospect seems unlikely now, market pricing must take into account the possibility of such a scenario. Currently, Treasury 10-year yields are reflecting this at around 4.47%.
Challenges for Longer-Dated Treasuries
Given the multitude of factors dampening sentiment, it will be difficult for longer-dated Treasuries to rally in the near future.
Closing Thoughts
As we consider the potential impact of neutral-rate fears on Treasury yields, it's clear that the financial landscape is complex and ever-changing. What are your thoughts on this matter? Do you agree with Kashkari's perspective, or do you see things differently? We'd love to hear your insights. Please share this article with your friends and colleagues. And don't forget to sign up for the Daily Briefing, which is delivered every day at 6pm.