Yields climb on Fed tapering bets

Post-Fed market impact

In the week that followed the September FOMC meeting, long-term Treasury yields continued their upward climb, peaking at 1.55% (intraday) before retreating somewhat below the 1.50% mark. While the market continues to balance expectations of the ongoing economic recovery and inflation, Fed tapering timing remains the largest driver of long-term rate movements. While a reduction in the pace of Fed asset purchases will undoubtedly put upward pressure on rates markets, it is important to note the Fed has not yet commented on a reduction of asset purchases, which would exacerbate rising yields. Rather the Fed will likely taper off the growth of its balance sheet as a prerequisite for short-term rate hikes before considering a return of its balance sheet to pre-pandemic levels.

Debt ceiling debate and Treasury supply

On a more technical note, temporary supply reductions may have kept rates lower in recent weeks. As the U.S. Treasury’s borrowing approaches the debt ceiling, the Treasury has drawn from GSA funding rather than issuing debt, thus reducing the supply of Treasuries in the market. However, a surge in supply following a raising of the debt ceiling and/or more fiscal spending would likely put upward pressure on yields. In either case, the market has faced yet another round of uncertainty surrounding the debt ceiling, with no clear path of resolution defined yet. While the Treasury Department stated it can continue funding until October 18, Congress is left with diminishing options to fund the government on a go-forward basis without a government shutdown. Of note, the debt ceiling has been raised 14 times since the year 2001.

Rates hedging implications

Corporate responses to last week’s volatility in rates have been mixed; many companies see the specter of Fed rate hikes as a sign to lock in floating rate exposure. While some companies look to place initial hedges, others are extending current exposure to hedge longer time horizons. In other cases, companies issuing fixed rate debt are assessing whether the damage is already done on higher long-term rates versus the fact that rates could continue to climb higher still.

(Related insight: Read "Managing interest rate risk on future debt issuances")

Energy

Most commodity and energy indices are higher across the board this week, with headline crude nearing $80 per barrel for the first time since 2018. Demand has continued to rise while OPEC is expected to keep supply steady at their meeting next week. Natural gas has also captured headlines, with wholesale prices in the U.S. exceeding $5, the highest price since 2008. While demand surges, bidding wars due to shortages in Europe and Asia have contributed to price steepening; with ongoing shortages in those jurisdictions coupled with elevated demand in the colder months, higher prices could linger. While no consumer likes the sound of higher heating bills, companies with these energy commodities as key inputs are assessing the costs and benefits of hedging in this higher price and higher volatility market.