Highest Yields Since 2007; R-Star at J-Hole?

The new week begins with bond yields at the highest levels since 2007 in what has been a broadly linear uptrend since late July.  Up until that point, rates had been holding in a narrow range for months more than 50bps below current levels. If the Fed was/is "data dependent," and if the most recent NFP/CPI reports were arguably bond-friendly, why has the trend been so unfriendly? 

Data has indeed mattered, but the bond market's strategic shift has mattered more.  In early July, markets returned from the Independence Day holiday to find a hawkish Fed Minutes release on Wednesday and a glut of unfriendly data on Thursday (including that ADP that came in at 497k).  This culminated in the first of two "apprehensive and defensive" sell-offs highlighted in the chart below.

In both cases, the selling pressure was driven by data and the Fed in the run up to NFP.  In both cases NFP helped calm the bond market's nerves with CPI solidifying the friendly bounce in the following week.  In the most recent example, the post-CPI resolve lasted only a few hours before bonds were blasting back toward the previous week's highs.  At the time, losses were exacerbated by Treasury supply concerns and foreign central bank selling in China/Japan.  

Fed policy is hurting long-term rates due to the yield curve.  Short-term rates are now high enough to hold mostly flat.  Until now, stronger data was able to do more to push Fed rate expectations (and 2yr Treasury yields) rapidly higher.  Higher rate expectations + the reality of tighter policy were like offsetting penalties for longer-term rates, thus allowing them to remain in a range.  But with the Fed shifting gears on short-term rates, bond market influences have a more direct impact on longer-term rates--all at a time when supply is increasing, foreign governments are selling, and the Fed is saying it's fine cutting short-term rates in the future while continuing to shrink the balance sheet.

To all of the above, add the fact that other economic data suggests the economy continues to chug along.  Some of the data suggests things are quite a bit stronger than expected.  The balance of all the available econ data adds general pressure (i.e. it supports the strategic shift to higher rates). 

Last but not least, there is buzz around the topic of the "neutral rate" or "R-Star" moving higher (the imaginary level of the Fed Funds Rate that keeps inflation and growth in a balanced homeostasis).  Some of the proponents of said buzz think Powell will discuss this Friday in Jackson Hole.  While a discussion wouldn't be a surprise, it would be a surprise if Powell were to say something about it moving higher.  If anything, there's an opportunity for Powell to put some of the rumors to bed by reiterating recent Fed communications regarding the absence of any change in the R-Star outlook.  At the very least, that would let us know how much this sentiment has affected the uptrend in yields recently.