Fed’s Cook says rising yields not tied to monetary policy outlook

By Howard Schneider

WASHINGTON (Reuters) – The recent rise in long-term U.S. bond yields does not seem to have been driven by investor expectations of further interest rate increases, Federal Reserve Governor Lisa Cook said on Monday, drawing a key distinction in how those market-based rates may be assessed within the central bank.

Market yields based on an expectation of further central bank actions would challenge Fed officials to follow through; those driven by other factors could tighten financial conditions and help slow demand and inflation independent of any other steps by the Fed.

“Decompositions between changes in expected rates and term premiums depend on the specific models and assumptions used,” Cook said in prepared remarks for an event at Duke University. “But I would say that an expectation of higher near-term policy rates does not appear to be causing the increase in longer-term rates.”

The interest rate on the 10-year Treasury bond has risen roughly a percentage point since the summer, breaching the 5% level late last month before dropping in recent days to its current level around 4.64%. The Fed has not raised its policy rate since July.

Cook did not comment on her specific view of the Fed’s policy rate, focusing instead on an overview of financial stability issues.

The U.S. central bank last week held interest rates steady, with Fed Chair Jerome Powell noting that higher market-based interest rates could serve the same inflation-taming end as increases in the central bank’s policy rate, as long as they are sustained and are not premised on further central bank action.

In her overview of financial stability, Cook said she felt that the banking system had weathered the stresses of last spring, and “remains sound and resilient overall.”

She also said that, in terms of borrowing, households and corporations seemed overall to be in good shape, though with stresses potentially beginning to emerge among those with lower credit scores and ratings “as would be expected in a rising interest rate environment.”

But Cook noted the risk that commercial real estate prices “could decline sharply” if commercial mortgage delinquencies rise and begin putting pressure on owners to sell. Office demand “has remained weak” in the wake of the coronavirus pandemic, she added.

Cook also said she was monitoring several possible risks among non-bank financial institutions, including those at highly leveraged hedge funds whose trades in Treasury securities could leave them open to funding shocks.