Headed into the June Fed meeting, analysts and strategists were keen to dissect last week’s “counterintuitive” action in rates which, on the face of it anyway, seemed demonstrably at odds with another hot read on inflation stateside.
By now, most serious traders and investors can offer some version of a plausible explanation for the current conjuncture, which finds 10-year US yields hovering below 1.50% despite the surge in realized inflation and an optically scary jump in consumer expectations.
The simple figure (below) shows… well, it just shows what it says it shows. Core CPI and PCE versus year-ahead expectations from the University of Michigan’s sentiment survey.
The market’s topic du jour is the disconnect between that (the upswing) and bond yields, which fell the most in a year last week. Note that while the figure shows the YoY prints for CPI and PCE, MoM gains clearly demonstrate base effects aren’t the only problem.
If you ask Morgan Stanley’s Mike Wilson, yields are reacting to what the market sees as “peak rate of change” for inflation.
“While all of these measures have moved sharply higher, they also appear to have peaked from a rate of change standpoint with the shorter tenures of the breakevens markets rolling over the hardest along with consumer expectations,” he said Monday. “The point here is that just like with many of our growth measures, it appears that the peak rate of change for inflation may be behind us.”
That’s good news from an “inflation scare” perspective, but what might be missing from the narrative is any hint that the economy could underwhelm. It’s all about “overheat” risk, but as Wilson remarked in the same note, the reversal in nominals and breakevens “could be an early signal that both growth and inflation may start to disappoint what are now lofty expectations.”
Although Morgan still projects robust growth, Wilson said demand in the first quarter was “extraordinary,” and doubts it’s sustainable. He cited fiscal stimulus, of course, but also crypto.
“The culprit in our view is a first quarter level of demand that was aided by $1.9 trillion fiscal stimulus and a rise in crypto currencies that added another $1 trillion to wealth,” he remarked, noting that “neither one of these are likely to be repeated in our view.”
At a more granular level, Nomura’s Charlie McElligott documented the beginnings of the squeeze, as (partially) revealed in CFTC-CoT, Fed and TFF data. He flagged “massive buying… with overall Non-Comm Spec adding $18.3 billion of USTs [during] the last weekly reporting period.” Delving into the details, Charlie said that,
Macro / Leveraged narrative- and positioning- having been so short, and critically, with trades getting increasingly expensive to hold from Theta- / Carry- / Roll- perspective and most expressions underwater since March—thus the obvious “unwind” flows over past 2w; Asset Managers known to be so underweight Duration YTD and thus net bot $15mm / 01 last week (with majority as “New Longs” not short-covers, and most Net since April of this year); Pensions now achieving fully-funded status and needing to buy fixed-income and de-risk, which looks to be the case with Treasury stripping activity making new all-time highs; and Foreign buyers increasingly seeing very attractive FX-adjusted yield pickup at 5-6 yr best levels, with the largest weekly demand in Fed Custody Holdings over the last weekly period since mid-March.
All of this literal buy-in is conspiring with (and is in part motivated by) figurative buy-in to the Fed’s “transitory” talking points, which officials have spent the last several months bludgeoning market participants half to death with.
Weighing in Monday morning, BMO’s Ian Lyngen noted that while “the most recent CoT data shows net spec positions in TY are at the longest since Oct 2017,” there’s no uniformity here. “Futures positions in FV, US, and WN all remain significantly short, even if slightly pared back from recent extremes,” he said, before ultimately suggesting that the “combined shifts are more consistent with scaling back from a core-short position as opposed to a wholesale capitulation and abandonment of the reflation trade.” One way or another, he added, there’s “no question that positions were responsible for a portion of the recent bid for Treasurys.”
If I were in the business of drawing conclusions (which I’m clearly not, as I usually raise far more questions than I answer in these pages), I might casually suggest that positioning is now “cleaner” into the Fed, allowing onlookers to take the market’s reaction to the statement and press conference at face value. (Insert chuckle.)