Federal Reserve officials may to go for another pause after surge in yields

Senior Federal Reserve officials are rallying around the idea that tighter financial conditions following a recent spike in U.S. Treasury yields could replace further hikes in the benchmark interest rate.

Fed Vice Chairman Philip Jefferson told a conference call Monday that he would “remain mindful of tightening financial conditions through higher bond yields” in assessing “the future path of policy,” echoing similar comments by other policymakers in recent days .

The key question for officials is whether the recent increase in borrowing costs reflects investors’ expectations of a stronger economy or simply additional compensation needed to take on interest rate risk. His deliberations are likely to keep them on hold at least until their next interest rate decision on November 1.

“The markets are suddenly doing all the dirty work for the Fed,” said Elena Shulyatieva, senior U.S. economist at BNP Paribas. “It looks like the majority, including some of the more hawkish politicians, are doing well to be more cautious.” The yield on the 10-year Treasury note has risen about 40 basis points since the Fed’s Sept. 19-20 meeting – up 4.8 percent by Friday’s close. Forecasts released after the meeting showed most officials expect one more rate hike this year — and fewer cuts next year — will be needed to return inflation to 2 percent.

Earlier Monday, speaking at the same conference as Jefferson, Dallas Federal Reserve President Laurie Logan indicated that if risk premia in the bond market rose, it “could do some of the cooling of the economy for us, leaving less need for further tightening of monetary policy.”

Logan’s comments at the National Association for Business Economics meeting coincided with similar remarks by San Francisco Federal Reserve President Mary Daley, who said on Oct. 5 that “if financial conditions, which have tightened significantly over the past 90 days, remain tight , the need for us to take further action is reduced.”

Investors currently see little chance of a rate hike at the Oct. 31-Nov. 1 meeting and are assigning less-than-even odds to any further tightening in 2023.