Treasury Volatility Escalates Amid Mixed Fed Signals and Middle East Tensions

The U.S. Treasury market is experiencing significant volatility due to a robust domestic economy, unclear signals from the Federal Reserve, and escalating geopolitical tensions in the Middle East. The traditionally safe asset has seen substantial yield fluctuations, with some market participants predicting continued instability.

On Monday, Fed Chair Jerome Powell hinted at steady interest rates at the next meeting but did not rule out another hike if robust economic growth persists. This led to an aggressive steepening of the rates curve, with short-dated yields falling while longer-maturity ones hit new multiyear highs.

Mike Schumacher of Wells Fargo Securities anticipates this high interest-rate volatility will persist until more clarity on the Fed’s long-term vision emerges and the Middle East situation stabilizes. Mohamed El-Erian from Allianz (ETR:) SE also attributes part of this uncertainty to the Fed’s difficulty in articulating a clear long-term vision for interest-rate policy.

Geopolitical concerns over the potential expansion of the Israel-Hamas conflict throughout the Middle East have also contributed to price swings. Ongoing drone attacks in Iraq and Syria, missile firings towards Israel by Yemen’s Houthi rebels, and Israel’s strikes against Hamas and Hezbollah have led investors to seek safety in Treasuries. As a result, 10-year yields dropped from just below 5% to around 4.91% by week’s end.

The rising U.S. debt issuance has also played a role in increasing long-end rates. Over the past three months, the term premium has risen by more than a point due to increased auction sizes announced by the Treasury. Traders are preparing for further increases at the Treasury’s next quarterly refunding on November 1.

William Marshall from BNP Paribas (OTC:) SA noted that the current volatility is creating more uncertainty. He suggested that a pause in Fed commentary this week, due to the central bank’s quiet period before the November 1 policy meeting, might offer traders some respite. However, key readings on price pressures in the economy are still due later this week, including Friday’s personal-consumption expenditures data and the University of Michigan inflation expectations survey. The upcoming week will also see a series of economic data releases as per the scheduled calendar, and several auctions as part of the auction calendar.

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