Fed already has a cap on long-term bond yields

There was something of a watershed moment in the $21 trillion US Treasury market. After a period of relentless selling that pushed longer-term yields to their highest levels in a year, Federal Reserve Chair Jerome Powell had one last opportunity to quell investors’ nerves before the central bank’s self-imposed blackout period.
Instead, he said that he’s not too bothered by the moves and that traders are on their own. Mic drop. This kind of attitude naturally raises the question of just how high longer-term Treasury yields can go from here, given expectations for one of the biggest years of US economic growth in decades. The benchmark 10-year yield is already up 66 basis points since the start of the year, on pace for the fourth-steepest quarterly climb since the 2008 financial crisis. Could it soon reach 2%, or 2.5%, or even 3%?
As I’ve noted before, the Fed only has direct control over shorter-term rates while longer-term yields are more prone to move based on market expectations for economic growth and inflation. But that’s not to say the central bank has no say at all over the long end of the yield curve. Its “dot plot,” which shows policy makers’ projections for the fed funds rate, includes median estimates for not just the next few years but also the “longer term.” Currently at 2.5%, this is the “neutral rate” at which monetary policy is neither accommodative nor restrictive and keeps the economy at maximum employment with inflation around 2%. In the first dot plot in 2012, the median longer-term rate was 4.25%.
Almost without fail, the Fed’s longer-term dot has served as a soft cap on longer-term Treasury yields. While it’s certainly possible that this economic recovery will be different from the last one because of supportive fiscal policy and the central bank’s new monetary-policy framework, for now it should be considered a guidepost for bond traders about just how far the selling can go.
A chart of the 30-year bond yield relative to the longer-run neutral rate tells a clear story. It’s likely little coincidence that selling abated at the end of 2013 right around the time the long bond yield approached 4%, the same level as the median estimate of the longer-term dot.
Again during the Fed’s tightening cycle, the bond yield hovered around the longer-term dot for much of 2017, 2018 and the first half of 2019. The 30-year yield touched a recent peak of 2.39% on February 25 — history suggests a clear break through 2.5% will be challenging.
Comparing the 10-year Treasury yield relative to the longer-run neutral rate puts scrutiny on late 2018, when it shattered the implicit 3% ceiling and markets quickly went into a tailspin, forcing Powell to abruptly pivot and lower interest rates in 2019.

—Bloomberg