“The coiling effect creates kinetic technical tension which is more likely than not to resolve in a range-breaking move at a point in the near future”, BMO’s Ian Lyngen said of Treasury yields this week.
How’s that for dramatizing things?
As you’re probably aware, yields have been stubborn in 2020 thus far. A recalcitrant long-end has refused to validate the reflation narrative. The promised bear steepener hasn’t panned out.
Instead, 10-year yields have meandered around between 1.75% and 1.95% for most of the last three months, with the only serious break coming in the chaotic minutes around Iran’s counterstrikes on US interests in Iraq. That move was fleeting.
“The three-month closing range is just a little over 25 basis points”, Bloomberg’s Luke Kawa writes, in the latest edition of the “Weekly Fix” letter. “That’s the tightest such spread since September 2018 – right before US stocks put in an intermediate top and yields punched through 3% and began to look like they’d keep going and going”, he adds.
This is one time when “rangebound” is actually some semblance of interesting, precisely because it has prevented the reflationists from declaring victory after piling into trades tied to the pro-cyclical rotation that defined the market zeitgeist in the fourth quarter. Instead of the long-end selling off in recognition of the improving prospects for global growth, we’re stuck.
“[A] Goldilocks US Economy with benign inflation, [the] Fed’s asymmetric policy reaction function alongside my belief that ‘QE-Lite’ turns to ‘outright QE’ in time and the secular disinflationary realities of the ‘Three D’s’”, continue to weigh on long-end yields, Nomura’s Charlie McElligott said Thursday.
Of course, you don’t want a runaway bear steepener. That would be a veritable disaster. What we’re talking about here is a controlled, “healthy” rise in long-end yields and a benign steepener that suggests the bond market has some faith in global growth. And we aren’t getting that.
Meanwhile, the UST-bund spread tightened inside 200bps for the first time since Vol-pocalypse last week. At the same time, the correlation between US and German 10-year yields has collapsed.
This speaks to a point we made a week ago. It could be that the US long-end simply isn’t the “right” place to go looking if you’re searching for evidence of reflation optimism. Bund yields are back to levels last seen prior to the summer plunge. It seems strange to describe negative 22bps as “lofty”, but that’s some 50bps higher than August. 10-year yields in the US, by contrast, have risen just 36bps off the August lows.
What happens from here? Well, as usual, nobody really knows. As SocGen’s Albert Edwards has been keen to point out, strategists have a penchant for projecting higher US yields. “Bond strategists really leave me perplexed, in that – in the teeth of a relentless bull market raging since 1982 – they still consistently forecast a year-ahead rise in yields against the trend”, Albert wrote last month.
The tendency to suggest that yields will be higher a year hence is obviously the product of strategists being unwilling to implicitly adopt a pessimistic outlook on the economy. But for right now, most remain generally bullish on bonds or, if they’re bearish, it’s with a tinge of caution.
Geopolitics is “a tail risk that can help Treasury yields decline and add to the asymmetry for front-end yields to fall rather than rise”, Morgan Stanley’s Matthew Hornbach said earlier this month. “The impetus for a more concerted move higher in yields is still absent”, Goldman noted last week.
Of course, with the front-end anchored by the Fed’s express desire to stay on hold, shocks arrive at the long-end. The curve “[has] been and should remain broadly directional with duration moves given well anchored Fed expectations”, Goldman says. That means it’s either bull flatteners or bear steepeners. The reflationists are hoping for the latter although, as noted above, nobody wants an explosive, out-of-control bear steepening episode.
As far as stocks go, the correlation between the S&P and 10-year yields is now the most negative since July.
It’s “remarkable” that 10-year yields are still below 2% in the US considering the big gains for risk assets, Morgan Stanley’s Hornbach said last week, calling it “a sign that the dovishness of the Fed is now well entrenched in the pricing of macro asset classes”.
[FYI: Bloomberg’s “Weekly Fix” letter is free and you can sign-up in the upper-right hand corner of their Fixed Income page here.]