Thanks to Friday’s post-NFP rally, 10-year yields ended the week near the low-end of the recent range, but the sideways drift continued.
While you might argue the range is “wide” as far as ranges go, benchmark yields have gone mostly nowhere since the rates mini-tantrum in Q1. “1.464% is the new local yield low print for 10s, but 1.527% is still the bottom of the range on a closing basis [and] could hold weight as resistance,” BMO’s US rates team said Friday.
“Treasurys remain stuck in the middle of the range we’ve seen since early April, with no clear catalysts for a change,” SocGen’s Subadra Rajappa remarked. “The 10-year being stuck reflects the tug-of-war between expectations for a strong recovery and volatile data prints as the economy gradually comes back online.”
The “tug-of-war” described by Rajappa was on display Friday, when NFP printed a somewhat ambiguous 559,000.
In normal times, there wouldn’t be anything ambiguous about that. It would be a blockbuster. But in the current context, 559,000 produced perplexed, furrowed brows. And also some relief for equities, which love a “Goldilocks” print that keeps the recovery narrative viable while allowing the Fed to retain plausible deniability when it comes to insisting that the “forward progress” witnessed thus far doesn’t count as “substantial.” (Loretta Mester made just such an argument on Friday.)
One thing to note about rangebound 10s is that, taken at face value, current levels suggest rates believe the Fed’s “transitory” narrative. Ahead of next week’s CPI print (for May), it’s worth asking where 10s “should” be if history is precedent considering April’s 10-standard deviation overshoot (figure below).
“While in terms of its levels the last core CPI print doesn’t reside in extreme territory, its change from the previous release certainly stands out,” Deutsche Bank’s Aleksandar Kocic wrote, in a Friday note. “The last move was a 10-sigma event based on the last 35 years of history.”
That, Kocic remarked, is a “genuine outlier,” and yet 10s have “done practically nothing.”
The figure (below, from Deutsche) shows nearly four decades of interaction between core CPI and 10-year yields. The red squares are March and April’s points.
The green arrow shows yields moving sideways despite the surge in core prices. “If the inflation threat had been perceived as real and 2.9% taken at face value, [10s] should have repriced above 4% [and] perhaps even significantly higher,” Kocic wrote.
The “deficit” (between 10s at ~1.56% and where they “should” be) suggests rates are “ignoring” last month’s CPI print and are thus “fully on board” with the Fed’s narrative, Kocic wrote. The yellow triangles show what Kocic calls “the proportion of disbelief” expressed as as a fraction of the underlying beta.
This assumption of credibility could prove fleeting, though. “Even inflation hawks agree that the most recent prints are biased by base effects and reopening dynamics,” Goldman’s David Kostin said Friday. That probably accounts for quite a bit of the benign market reaction to April’s CPI scorcher, and there’s also a sense in which rates (and equities) pulled the expected inflation spike forward into the first quarter, markets being forward looking beasts.
Now, the onus is on the data to i) validate the prices which resulted from that pull-forward, and then ii) consistently top estimates in order to “confirm” the overheat narrative. The latter is a high bar, and the most recent data suggests it’ll be hard to clear.
“Equity market performance already shows a recent unwinding of inflation concerns,” Kostin went on to say. “In March, amidst fears about rising inflation, stocks with high pricing power began to outperform those with low pricing power [but] during the past few weeks, low pricing power stocks have outperformed again,” he added.
As for rates, if the Fed is right (where that means realized inflation “disappoints”), the curve would “fully embrace” the Fed’s “transitory” narrative, Kocic said, noting that while 10s are already pricing this in (at least partially), “both 5s and 30s could rally hard, leaving 10s behind.”
If, on the other hand, there are additional hot CPI prints which cast doubt on the “transitory” story, the market would probably begin to anticipate a bit more in the way of urgency around the policy normalization push.
In that case, “the magnitude of the move would be a function of the Fed’s reaction and interpretation of the numbers, making the five-year points’ repricing contingent on that [while] a selloff in the 30-year sector would be largely unconstrained by the Fed,” Kocic wrote, after noting that notwithstanding current buy-in vis-à-vis the “transitory” talking point, “the Fed could be engaging in a risky maneuver [as] there is no historical situation that convincingly exonerates the present actions against the backdrop of the existing policy mix.”
