On Thursday afternoon, following a rally on Wall Street predicated on rampant trade optimism, we noted that suddenly, 2% on 10s was “squarely back in play” after yields exploded 11bps higher on the session. It was one of the worst days for the long bond ETF since the election.
Fast forward 24 hours, and Treasurys recouped the majority of Thursday’s declines. Yields were 5-7bp lower across the curve. 10s are now back down to 1.82%.
The Friday advance for bonds was a reflection of disappointment in the lack of specifics around the fledging agreement between the Trump administration and China. The USTR worked throughout the day to convince skeptical market participants that the truce isn’t as nebulous as it sounds – that the US will get more than an influx of Chinese catfish. Bob Lighthizer, for example, detailed the math around prospective farm purchases, but nobody seemed convinced.
Read more: Lighthizer, Kudlow Talk Up Trade Deal As Skeptical Market Questions Farm Math
Part and parcel of the case for higher yields and a steeper curve (and, by extension, for a resumption of the pro-cyclical rotation trade, which has demonstrated an annoying propensity to poke its head out like a turtle, only to retreat back into the shell at the first sign of trouble as bond dips are bought) is the notion that clarity on trade will pave the way for better data and higher breakevens.
If you ask Goldman, the narrower-than-expected “Phase One” deal likely means there’s a ceiling on yields, even as movement on the USMCA adds to a general sense of optimism around the near-term outlook for trade.
“This is a narrower deal than we (and markets) were expecting, and we believe the likelihood of further progress beyond a Phase 1 deal remains low before the presidential election”, the bank wrote on Friday evening.
Donald Trump (as well as Larry Kudlow) insisted that work on “Phase Two” would begin immediately, but it would be entirely fair to say that nobody believes there will be a breakthrough on that front prior to the election. Indeed, it’s not even clear what the next “phase” will encompass.
“Given the narrow scope of the deal, achieving 2% for 10y UST yields may be hard by year-end, though directionally, we continue to expect yields to be biased higher”, Goldman goes on to say. The bank does add that “investors appear somewhat long per our positioning metrics, which when combined with low liquidity in the second half of December, could lead to exaggerated moves to the upside”.
Over the medium-term, with the Fed on hold and the incoming data set to improve, Goldman still sees support for breakeven wideners.
You’re reminded that not everyone is on board with the idea that the US economy is going to perform well in 2020 or that the Fed will be able to refrain from cutting rates further.
Both BNP and SocGen expect cuts in the first half of next year. SocGen’s Subadra Rajappa (who was on BBG TV Friday), sees 10s at just 1.20% in Q4 2020.
Read more: Why Subadra Rajappa Sees US Treasury Yields Falling To 1.20%
