Inflation, too, is decelerating, although not as fast as policymakers would like. The Personal Consumption Expenditures Price Index—the Federal Reserve’s preferred barometer of inflation—rose 0.2% in July for the second straight month, which has put some upward pressure on yields. Still, the index is coming off its lowest annual rate in more than two years.
Additionally, regional banks are facing liquidity pressures. The Fed’s Bank Term Funding Program, which was designed to shore up liquidity in the US banking system, will expire in March 2024. With banking liquidity a persistent concern and regional lenders trying to offload private-credit debt and levered loans from their balance sheets, regional banks may provide the Fed with one more risk to consider. This is particularly true given their importance as lenders to small and medium-size businesses.
Economic Risks May Also Pressure Yields
Treasury yields could also fall if other barometers of economic health deteriorate. The Institute for Supply Management’s Purchasing Managers’ Index—a reliable indicator of business sentiment—came in weaker than expected in August. Historically, there has been a relationship between PMI levels and Treasury yields, so this index will bear watching.
The US budget deficit could also factor in. According to the Congressional Budget Office, the cumulative deficit for the period spanning 2024–2033 is expected to top $20 trillion, or more than 6% of US GDP. Exceeding the 6% threshold is a historical rarity. If the cost of servicing its debt rises, the US government won’t have as much to spend on other programs, which could become an impediment to economic growth.
Of course, the Federal Reserve will have the final say. With the target fed funds rate at 5.25–5.5%, monetary policy is already in restrictive territory. If economic growth is steady but inflation continues to decelerate, the Fed is likely to steer interest rates toward its policy-neutral 2.5% rate. If the US falls into recession, rates could fall even more (Display).