Treasury Yields Seen Inching Up Even With Balanced Fed Message

Signs are growing that U.S. Treasury yields may continue to march higher even if Federal Reserve Chair Jerome Powell strikes a balanced tone at Jackson Hole this week.

The yield on five-year government notes -- the tenor that simultaneously captures expected changes to short-term interest rates and the pace of purchases of longer-dated bonds by central banks -- has climbed almost 20 basis points from a low this month, extending its underperformance against the rest of the curve since February.

It comes as the market appears to have largely discounted the prospect of a hawkish tilt by Powell, who is expected to hint at an eventual reduction of monetary stimulus at the Fed’s annual symposium. For ING strategists led by Padhraic Garvey, their relative cheapness against two- and 10-year peers points to “residual” momentum for higher rates.

“There is enough there, together with more balanced positioning, for market rates to start testing higher levels,” ING’s Garvey said. “It may be tentative, but it looks like the path of least resistance.” The latest clues on investor appetite for U.S. government debt may come later today, when the Treasury sells $61 billion of five-year notes in an auction.

Meanwhile, algo models driven by momentum, volatility and carry considerations have been unwinding long positions in the Treasury market, according to Mohit Kumar, a strategist at Jefferies International. That means flows might be enough to keep Treasuries on the backfoot, even if Powell declines to give a clear signal as to when he’ll begin removing support from the bond market.

“The last two months were positive for duration with supportive carry seasonality and low volatility,” Kumar, who is short five-year Treasuries, said. “We expected some unwind of long positions as we head into the volatility event of Jackson Hole and the carry seasonality wanes.”