The Tell

How Fed’s higher-for-longer theme may play out in Treasurys and the dollar on Wednesday

Members of the Federal Open Market Committee have convened in Washington and are set to release their next policy announcement on Wednesday.

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In the run-up to Wednesday’s Federal Reserve policy decision, strategists at TD Securities are pinpointing two places in the financial market that are most likely to shift as the result of a continued higher-for-longer message on interest rates: Treasury yields and the U.S. dollar.

In a note released on Tuesday, strategists Oscar Munoz, Gennadiy Goldberg, and Mark McCormick said they expect the 10-year Treasury yield BX:TMUBMUSD10Y to experience a slight bump-up from Tuesday’s level of around 4.3% under their base-case scenario in which the Fed leaves open the possibility of another rate increase in November or December, while Fed Chairman Jerome Powell indicates that officials are in no rush to ease policy next year. The TD strategists also expect the U.S. dollar to edge higher.

Wednesday’s policy announcement by the Federal Open Market Committee is widely expected to produce a pause in rate hikes. Still, the update matters because of what it’s likely to signal for the rest of the year and 2024, at a time when higher oil prices are adding to jitters about a revival in inflation.

Powell’s answer to the question of how long rates will stay high has the potential to undercut the 2023 stock-market rally, some said. Meanwhile, Joseph Davis, chief global economist and head of?Vanguard’s?investment strategy group, said the Fed may need to possibly raise rates one to three more times from a current range of 5.25%-5.5%, and then stay at those elevated levels until late 2024.

Read: Why the Fed’s response to this key question could spark a 5% stock-market pullback

“We expect the Committee to continue shifting to a message of ‘higher for longer,’ though Powell’s presser/dot plot revisions might have a hawkish flavor to them as Fed officials are not ready to discard further rate increases,” Munoz, Goldberg and McCormick wrote. Rates traders “have already decreased pricing for 2024 cuts.”

The TD strategists see a 70% likelihood of their base-case view coming to fruition, which they said should lead to a roughly 4-basis-point rise in the 10-year Treasury yield, a slightly more negative spread between 2- and 10-year rates, and a 0.1% rise in the Bloomberg Dollar Spot Index — all relative to Tuesday morning’s levels.

“It’s really the backup in the long end of the Treasury market that’s getting a lot of attention, and what’s going to be the focus for a lot of investors,” Goldberg said via phone on Tuesday. “We’ve had a lot of repricing for higher-for-longer rates, which has been pushing long-end rates higher over the course of the past month or so. Everyone wants to know if the Treasury curve will keep steepening, driven by the long end and greater expectations for a soft landing.”

Under a more hawkish scenario — in which Fed officials strongly hint at another 2023 rate hike, downplay recent signs of cooling inflation, and project fewer 2024 rate cuts, while Powell also signals that more hikes are needed — the 10-year rate could rise by 8 basis points, the 2s10s curve would go even further below zero, and the Bloomberg gauge would jump 0.25% from levels seen early Tuesday, the TD team said.

Source: TD Securities

On Tuesday, the 10-year yield finished the New York session at 4.366%, its highest level since Oct. 31, 2007, based on 3 p.m. Eastern time figures. The 2s10s spread went more deeply negative at minus 74.3 basis points and all three major U.S. stock indexes DJIA SPX COMP ended lower.