US Long Bond slumps on positive economic data, remarks by Fed's Powell

The head of the US central bank sounded a very confident note on the outlook for the US economy on Wednesday evening, contributing to a sharp move higher in US government bond yields.

Speaking at an event hosted by The Atlantic magazine and the Aspen Institute, on Wednesday, Powell defended that a gradual path of interest rate hikes was the best way to move forward but also said America was experiencing "a remarkably positive set of economic circumstances."

His remarks saw the yield on the benchmark 10-year US Treasury note climb 11 basis points to 3.21%, which was a fresh 52-week high and the highest in at least five years, according to Bloomberg data.

Two-year note yields meanwhile jumped by six basis points to 2.88%, which according to the CME's Fed Watch tool meant that Fed fund futures were left pricing-in a 81.7% probability that the central bank would hike the target range for the Fed funds rate again, by 25 basis points, to between 2.25% and 2.50% when they next met on 19 December (versus 70% odds the day before).

Significantly, the Treasury yield curve in fact steepened on the back of the move, with the spread between two and 10-year government notes reaching 33 basis points.

As well, the yield on the so-called 'Long Bond' jumped by 12 basis points to 3.34%, pushing past its previous 52-week highs to reach its loftiest level since mid-2014.

Powell was referring to the combination of low and steady inflation alongside very low unemployment.

He also said that the monetary authority might raise interest rates past their neutral setting, adding that "we're a long way from neutral at this point, probably".

Indeed, he said: "There's really no reason to think that this cycle can't continue for quite some time."

"NOT SO FAST", says Panmure Gordon

Commenting on the potential implications of the move higher in US Treasury yields, Panmure Gordon said: "With the US ten-year Treasury yield hitting their highest level since 2014 there is understandable angst on how quick and how damaging a bond market unwind can be.

Our view is that much of the structural demand for long-dated income remains intact, whilst the paucity of yields available in other developed markets will limit the upside risk. The transmission of higher yields into the real US economy remains modest with 30-year mortgages available at 4.75% and AAA-rated debt at 4.0%: "It is our view that long-dated Treasuries have to reach 4.0-5.0% before the transmission to lower growth and corporate earnings sets in.."

To take note of as well, Powell's remarks came close on the heels of better-than-expected readings on US private sector payrolls and the Institute for Supply Management's services sector Purchasing Managers' Index for September (and recent breakthroughs on trade deals).

On that note, analysts at Citi told clients that: "Low inflation prints have not been enough to give a bid to bonds. Domestic data has continued to be strong, but are mostly meeting already bullish expectations (the Citi surprise indices continue to tread water). Today's ADP release did come in higher than expectations and given that the sell-off took place after the release, we think that expectations of a blockbuster payrolls report on Friday are also playing a role in the selloff."

In Citi's opinion, treasury valuations were "attractive" even if sentiment was now 'bearish' and they were planning to add to their 'longs' in 10-year notes towards the 3.20% to 3.25% area.

However, there were risks to keep in mind, including "mortgage convexity hedging", continued selling by trend following funds or CTAs and a much stronger than expected US non-farm payrolls report on Friday.