Yield Curve Shifts as Market Reacts to Warsh and Bessent Comments

The yield curve is experiencing significant changes as the market reacts to recent statements from Fed Chair Kevin Warsh and Treasury Secretary Scott Bessent. The probability of a 25bp hike in interest rates from the September FOMC meeting has shifted from 50:50 to 3:1 in favor, indicating that higher front-end rates may be necessary. Meanwhile, the 10yr break-even inflation rate has eased lower by a few basis points, suggesting that Warsh's hawkish words have helped contain inflation expectations.

However, the 10yr yield continues to edge higher due to ongoing upward pressure on real yields, which are being driven by a combination of issuance pressure and positive productivity growth stemming from the AI revolution. This is consistent with Warsh's reference to a positive secular growth dynamic during the G20 summit in South Carolina.

Looking ahead, the front end of the yield curve may remain sticky at elevated yields unless negated by a weak payrolls report on Friday, while back-end yields continue to face rising pressure. Treasury Secretary Bessent can claim some success in containing long-tenor swap spreads, but the curve is expected to steepen from the back end.