A US official confirmed on Thursday that the Trump administration has agreed to roll back tariffs on China as part of the “Phase One” trade deal between the world’s two largest economies.
Chinese Commerce ministry spokesman Gao Feng originally broke the good news at a regular briefing, sending risk assets higher and setting the stage for US stocks to log new records.
Not surprisingly, the ongoing stream of positive trade news is perpetuating the selloff in US rates. 10-year yields jumped some 12bps on Thursday, and have nearly erased the entirety of the August plunge.
Futures volumes were running high, with activity in the 10-year note at 57% above the 20-day average through lunchtime. Meanwhile, bund futures were running at 90% above their average just prior to the close across the pond.
This is “just shy of a 3-sigma move in 10-year yields relative to one year [of] history”, Bloomberg’s Luke Kawa noted.
As a reminder, Nomura’s Charlie McElligott has variously warned that CTAs would likely start to unwind some of the legacy long in 10Y futures this week thanks to a flip “short” in the heavily-weighted 3-month window on the bank’s model.
“Rates are again breaking down… with further unwind of the crowded 2019 thematic ‘Everything Duration’ trades in both Rates and Equities continuing to extend, as the ‘worst case scenario’ is NOT playing out”, he wrote Thursday.
There’s a supply element in play here as well – the action came just ahead of an auction in the US and after auctions in Spain and France. It also comes amid heavy corporate issuance and ahead of a potentially large deal from AbbVie next week.
Some folks are taking profits. “The sell-off has gone far enough for some Treasury option traders, who appear to be scooping up profits on lucrative one-week bets that called the recent climb in yields”, Bloomberg’s Edward Bolingbroke noted on Thursday afternoon, adding that the morning’s price action appears to have prompted “profit taking on bearish option structures on 10- and 30-year futures”. Those trades, Bolingbroke says, “were struck last week with the level closer to 1.70%, resulting in a healthy profit north of $40 million as supply pressures have added to a more positive US-China trade backdrop”.
Crucially, the Fed is completely priced out for December. The front-end action in rates on Thursday shows STIRs pricing in less than a full cut going forward. In other words, markets are no longer priced for another full Fed cut. The optimism around the trade deal has effectively helped validate the Fed’s contention that the trio of cuts witnessed since July were, in fact, merely a “mid-cycle adjustment”.
“The Rates market is now accelerating the unwind of central bank ultra-easing bets, which was further pressured overnight by ECB’s Holzmann commenting that ‘Negative rates are the wrong signal at this point, therefore they should be withdrawn as soon as possible'”, Nomura’s McElligott remarked earlier Thursday.
Bear in mind that after the October Fed meeting, Trump insisted that Jerome Powell and company haven’t done enough. He is acutely aware that his leverage over the central bank resides in his ability to reignite trade tensions with a single tweet.
“The market moves are much larger, statistically highly significant, and more clearly skewed to the downside, ranging from -14bp to +4bp”, Goldman said last month, in the course of comparing the reaction in rates to Trump’s trade tweets to how Fed funds futures respond to monetary policy tweets. “Cumulatively, the impact on market expectations for the funds rate is about -40bp when we include tweets indicating escalation of trade tensions and tweets indicating de-escalation, and about -60bp when we focus only on tweets indicating escalation”.
As we’ve noted time and again, committing to the rollback of tariffs would almost surely mean the market prices out a December rate cut, thereby raising the odds that Trump decides to inject a little uncertainty in order to keep Powell on his toes.
The December Fed meeting comes within days of the deadline for the lifting of the next scheduled tariff escalation (on December 15) and if this week’s news flow is any indication, the White House has likely already committed to not moving ahead with those planned tariffs.
Barring a severe deterioration in the data between now and next month, that would rule out a December Fed cut, especially in light of the messaging at the October meeting and during the press conference.
Look for Trump to push back on that. He wants the Fed in play headed into an election year and he will not take “no” for an answer.