10-year US yields, the benchmark of all benchmarks, breached 5% on Monday for the first time since 2007.
At one juncture, 10s were cheaper by more than 10bps at 5.02%. The move was aggressively faded over the US session. Yields ended richer on the day, with the 10-year around 4.85%.
The initial selloff bear steepened the 2s10s to within ~11bps of positive territory.
Recall that the inversion was more than 100bps at the end of June, a post-Volcker extreme.
Although the curve was flatter by the time the dust settled, this continues to be a somewhat vexing dynamic. I’ve been over it again and again, but it bears repeating. I’ll recycle some language from an October 5 article. You don’t fear the inversion, you fear the re-steepening, and the rationale is straightforward: You’re typically looking at a bull steepener, and it usually means investors are anticipating rate cuts because the market suspects something is about to go wrong, or in some cases because something already has. This cycle, investors face disinversion by bear.
It’s not especially difficult to explain. The front-end can’t rally given the Fed’s determination to hold terminal for as long as the data permits, while the long-end is attempting to price a higher neutral rate, increased supply and wider deficits all with reduced participation from price-insensitive buyers.
As the figure shows, volatility has migrated out the curve. The picture looks the same for 30-year yields.
Bottom line: The front-end’s anchored, the long-end isn’t. The result is a bear steepener on days when bonds are under pressure.
That’s not necessarily a “bad” thing, but it merits caution for at least two reasons.
First, the long-end selloff since August was accompanied by a sharp increase in the term premium, and part of that is the market assessing the noxious mix of large deficits and acute government dysfunction. Deficits don’t matter for the US, but Washington is in the process of scoring an own-goal by validating otherwise dubious narratives about the demise of the dollar. The strength of America’s institutions is part and parcel of the dollar’s reserve currency status. Confidence in those institutions is waning both at home and abroad.
Second, long-end rates can only rise so far before the associated tightening in financial conditions spills over into the real economy and brings on the very recession the front-end wasn’t allowed to price because a resilient economy with above-target inflation precludes Fed easing. While the Fed certainly wants to preserve a portion of the FCI tightening brought about by higher yields, an untethered long-end is inauspicious. Self-evidently, you don’t want longer-term US notes and bonds trading like GameStop.
