US Growth Hits a Five-Year High; Bond Yields Hit a 19-Year High

A week ago the Fed raised rates, and the market read it as a ceiling.

The dot plot showed just one more hike by year-end. The 10-year yield fell and the Nasdaq rose.

Today that ceiling came off. Three pieces of news landed in a row: strong growth data, a Fed governor's remarks and a weak Treasury auction.

Growth Data Blew Past Forecasts

S&P Global's flash composite PMI, a survey-based gauge of business activity, rose to 58.4 in September from 56.0 in August. Anything above 50 means expansion, and this is the highest reading since July 2021.

The services index came in at 58.7 and manufacturing at 57.0. Forecasts were around 56.0 and 53.6.

Prices mattered more. Input costs rose at the fastest pace since October 2022. Chris Williamson, S&P Global's chief business economist, tied that to oil and flagged a shift in pricing power:

"companies are developing more pricing power, and hence is a worry for the inflation outlook"

Barr Named the Direction

Shortly after the data, Fed Governor Michael Barr spoke at a Chicago Fed housing conference. According to Reuters, he said risks to the inflation target have increased while risks to the labor market have receded.

"In my base case, further policy adjustments are likely to be needed"

Note the mood of the verb. "Likely to be needed" is a forecast, not a decision. Nothing is binding until the October meeting.

Fed Chair Kevin Warsh, by contrast, has declined to signal the direction of rates. Barr's line was the clearest hawkish signal yet from inside the Board.

The Middle of the Curve Led

A week ago the long end, such as the 30-year, drove the rise in yields; the story was supply. Today the picture flipped.

The 5-year rose the most and the 30-year the least. The belly of the yield curve bulged.

The market did not read this as a growth story.

It read it as a story about the Fed's path.

The Mechanism: A 5-Year Yield Is an Average

A 5-year yield is roughly the average of expected policy rates over the next five years, plus a term premium. How much one hike moves that average depends on how long it stays in place.

The math is a simplification; it sets the term premium to zero. But it makes one thing clear. The market extended not just October but how long rates stay high.

Futures now see four more hikes within 12 months as likelier than three, according to reports. The dot plot's median pointed to 4.1% at year-end, which means one hike.

Auction Demand Fell Short

In the afternoon the Treasury sold $70B of 5-year notes. The auction cleared at 5.033%, versus a when-issued yield of 5.002% just before.

That 3.1-point gap is the extra yield the seller paid to find buyers. The average over the last six auctions was 0.6 points.

Indirect bidders, a group that includes foreign central banks, showed up light. Dealers filled the gap. The 5-year yield topped 5% intraday and closed at 4.996%.

What Doesn't Fit the Story

The stock reaction was limited. The S&P 500 fell 0.73%, the Nasdaq 1.11% and the Dow 0.63%, well short of a 2% move.

Small caps, seen as the most rate-sensitive, fell harder: the Russell 2000 lost 1.60%. Energy was the only S&P 500 sector to rise.

For consumers the channel is open. According to Reuters, the 30-year mortgage rate stands at 7.12%, a two-year high.

The Treasury will run a $6B buyback on Sept. 24. That is small next to the $70B auction sold today.

What Remains

The next marker is the Fed's Oct. 27-28 meeting. September jobs and inflation data come first.

Barr's line is a forecast, not a decision. But the market used it in place of what Warsh has not said.

This article draws on S&P Global's Sept. 23 flash PMI release, the Treasury's daily yield curve data, Reuters' report on Barr, reports of the 5-year auction results and closing market summaries. Closing yields are market quotes and can differ by a few basis points across sources; intraday levels were higher than the close. Reported odds of an October hike range from 64% to 71%.