String Theory

Yellen's Masterful Bond-Market Puppet Show

It's a delicate dance to keep things moving without tipping them over.
Photographer: Richards/Fox Photos/Getty Images

Federal Reserve Chair Janet Yellen has proved to be amazingly adept at giving speeches that are widely open to interpretation, giving everyone a little of what they want to hear without shocking the markets.

At the same time, she has also managed to subtly shift the market toward where she wants it to go.

On Tuesday, in a speech Cleveland, she demonstrated this ability by saying both that the Fed "should also be wary of moving too gradually" with tightening policy but offsetting that by admitting that the central bankers may be overestimating the U.S. economy. Traders initially seemed to take note of the hawkish tilt, slightly pushing up yields on two-year U.S. Treasuries, which are now at the highest level since October 2008.

Steady Rise

Yields on two-year Treasuries rose after Fed Chair Yellen spoke Tuesday

Source: Bloomberg

The dollar also strengthened slightly against its peers, possibly on the prospect of more aggressive policy tightening by the U.S. central bank. Both moves were dampened as Yellen answered questions and demonstrated her typical tempered approach to assessing the nation's growth.

Blip Upward

The U.S. dollar strengthened against its peers after Fed Chair Yellen spoke Tuesday

Source: Bloomberg

At the same time, a big minority of investors seem to think the central bankers will be forced to slow down and reassess their approach because of a weaker-than-expected U.S. economy. Some will point to the narrowing yield curve to prove this; the gap between yields on 30-year and two-year Treasuries, for example, shrank further, to the least since 2007.

Converging Yields

The gap between shorter and longer term yields has been steadily narrowing

Source: Bloomberg

Either way, there has been one clear reaction by bond traders: Implied chances of a December interest-rate increase by the Fed rose after already increasing considerably over the past several weeks. They reached nearly 70 percent in the wake of Yellen's comments from as low as 22 percent earlier this month, according to trading in futures contracts tracked by Bloomberg. This is making it easier for the Fed to go ahead and make another move this year despite the somewhat inconclusive U.S. economic data.

Rising Probability

Traders are getting more confident that the Fed plans to raise rates again in December

Source: Bloomberg

The big takeaway is not that the Fed is omniscient or has some grand unstated plan. It is that Yellen is a masterful puppeteer of the $14 trillion U.S. Treasury market. She has honed a knack for giving it just enough information to tilt it in the direction that seems appropriate to her without causing a massive jolt. As President Donald Trump leans against reappointing Yellen to another term, it's worthwhile to appreciate this finesse. It will likely be sorely missed come next year.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Lisa Abramowicz in New York at

    To contact the editor responsible for this story:
    Daniel Niemi at

    Before it's here, it's on the Bloomberg Terminal.