How rising yields could sway the Fed's rate decision

Treasury yields orbit 5% just as Fed regulators seek clarity as to whether or not to hike interest rates in the final months of 2023. RBC Capital Markets Head of Rates Strategy Blake Gwinn details the Fed's mindset and why it may seem "very reluctant to continue rising rates."

"If longer-term rates are moving up and these mortgage costs and other ways it impacts the economy, if those are starting to get tighter and those financial conditions are tightening on their own, we need to do less," Gwinn explains to Yahoo Finance.

Click here to watch the full interview on the Yahoo Finance YouTube page or you can watch this full episode of Yahoo Finance Live here.

Video transcript

BRAD SMITH: Blake, even as we think about the expectations going into the next Fed meeting, too, and how this could continue to impact yields, much of the anticipation, at least from the CME Fedwatch Tool, is that there's going to be no change, that there's going to be no decision that would ultimately kind of move rates higher at this next meeting. So how does that calculate into the yield move that we're watching right now?

BLAKE GWINN: Well, two things. So let me just tell you where I'm at on the Fed. I agree with what's basically priced in the markets, that they're going to pause in November. I think the Fed speak we've seen over the last few weeks, heading into the blackout period ahead of this, shows a Fed that is very reluctant to continue rising rates. We just heard a lot of discussion about what higher rates, higher term premium can mean for consumers, for borrowers.

And I think the concern that you're seeing from Fed members is that they are looking at these higher rates and thinking, hey, this is doing some of our work for us. We don't need to continue hiking rates. If longer term rates are moving up and these mortgage costs and other ways that it impacts the economy, if those are starting to get tighter and those financial conditions are tightening on their own, we need to do less. So I think you've seen that kind of vibe from the Fed speakers over the last two weeks, where they seem like the bar to continue hiking is very high.

As far as what that means for these moves continuing, I think with the Fed on hold and not wanting to hike more, you do take away some of the upside risk to front end yields. But I think what's interesting is after Powell, we actually saw curves continue to bear steepen after he delivered what I think was widely viewed as a dovish message. Typically, when you get dovish Fed speak, you actually see a bull steepening because people start to price out those frontend additional Fed hikes. They start to price in additional cuts.

But this time, we saw a bear steepening. And I think that's because when you couple the strong data that we've had with a Fed that seems very resolute to not hike again, that starts to add some upside risk to long-term growth and inflation. And that manifests itself through higher backend yields, through higher term premium through a steeper curve.

So I do think with the Fed on hold, if the data continues to be strong, as we saw with NFP, CPI, retail sales, if that kind of strength in the data continues and the Fed still says, hey, we're not moving, it's possible that this term premium move could continue, except now it's more about upside risk to inflation growth than it is supply and demand for Treasury securities.