Bond Report: Treasury yields edge lower from 2-month high amid Fed’s policy framework shift

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U.S. long-term Treasury yields slipped lower Friday as investors processed data on the health of the economy in the aftermath of the Federal Reserve’s historic announcement on policy.

On Thursday, Fed Chairman Jerome Powell said the central bank would aim for an average annual inflation rate of 2%, shifting longstanding policy that are likely to have lasting impacts on financial asset prices.

What are Treasurys doing?

The 10-year Treasury note yield TMUBMUSD10Y, 0.718% fell 2.9 basis points to 0.715%, a day after marking its highest yield since June 16, while the 30-year bond yield TMUBMUSD30Y, 1.495% pulled back 1.2 basis points to 1.487%, after the long bond notched on Thursday its highest since June 17.

On Thursday, the yield for both the 10-year note and 30-year bond saw their biggest daily increase in two weeks.

The shorter 2-year note rate TMUBMUSD02Y, 0.132%, meanwhile, retreated 3.7 basis points to 0.121% on Friday. Bond prices move inversely to yields.

On top of that, the yield curve, or differential in rates between the two-year and 10-year Treasurys, touched around 59 basis points, its widest in recent weeks. The yield curve is often viewed as a measure of how investors think about the health of the economy.

What’s driving Treasurys?

Fixed-income markets were parsing the Fed’s decision on Thursday to alter its policy framework by aiming for a yearly average inflation rate of 2%. in contrast with the past policy of pre-emptively raising rates when inflation neared 2%. The Fed’s new policy thinking also allows the labor market to strengthen, with unemployment, lower for longer periods without it raising alarms by policy makers.

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On Friday, investors were digesting a batch of economic reports.

Data showed U.S. personal income rose 0.4% in July, while consumer spending was up 1.9%. Economists surveyed by MarketWatch expect had expected income to fall another 0.4% after a 1.1% drop in June. Spending was expected to show a 1.6% rise after a 5.6% increase in June.

Spending on durable goods is up 12.2%, while spending on services is down 9.3% for a net shortfall of 4.6% in total consumer demand, said Aneta Markowska, chief financial economist at Jefferies, adding that the variation in spending patterns explains “part of the disconnect between the stock market and the economy, since the former has much less exposure to the service sector than the latter.”

Meanwhile, the final reading of the University of Michigan’s August consumer sentiment index came in at 74.1 versus a preliminary reading of 72.8 and up from 72.5 in July.

The data come as Fed officials on Friday offered a measured outlook for the U.S. economy, which is still wrestling with the COVID-19 pandemic. “I do believe that the recovery is likely to be a slow one,” said Cleveland Fed President Loretta Mester, in an interview on CNBC.

In at later interview on the business network, Philadelphia Fed President Patrick Harker said he thought job growth and consumer spending were moving sideways in August.

“It will take a while for the employment situation to heal,” he said.

Harker and Mester are voting members on the Fed’s interest-rate committee this year.

Separately, market participants were watching news that Prime Minister Shinzo Abe would resign due to illness. Abe, whose term ends in September 2021, is expected to remain in office until a new party leader is elected and formally approved by parliament.

The Japanese 10-year government bond TMBMKJP-10Y, 0.059%, known as JGBs, was trading with a yield of 0.059%. Japanese shares fell sharply, leaving the Nikkei 225 Index NIK, -1.40% down 1.4%.

What are market participants’ say?

“Powell characterized permissible overshoots as moderate (“which is to say not large”) and for some time (“which is to say not permanent”), but he emphasized that it was important for people to “understand that this is not a formulaic approach […] the Committee will continue to consider all of the things that it typically considers in making monetary policy, but we’ll aspire to have inflation run above 2% after periods in which it runs for an extended period below 2%,” wrote Morgan Stanley analysts in a research report published on Friday.