With allowances for the pressing nature of concerns about the next phase of the Iran war, it’s fair to say the most important question facing market participants currently is how far 10-year US yields will ultimately rise.
And because the answer’s inextricably bound up with the trajectory of crude prices, the war question and the bond question are closely related.
As Kevin Warsh was keen to point out during this month’s post-FOMC press conference, the 10-year Treasury’s “the most important asset anywhere in the world” — the risk-free rate upon which “virtually every price in the world” is based.
That rate’s up 100bps this year, with half of the increase coming since the Fed’s July policy meeting. Consider this: The 52bps increase in benchmark US yields since the July FOMC gathering constitutes the steepest jump from the meeting before the first rate hike in seven hiking cycles going back three decades, according to BMO’s Ian Lyngen and Vail Hartman.
There’s the chart. We’re currently on the 2022/2023 hiking cycle path which… well, that’s an ominous precedent on a number of fronts.
“That episode entailed the most aggressive Fed tightening” since the 1980s, and 10-year yields rose by over 200bps, Lyngen remarked.
I mentioned this in a comment a few days ago, but I want to be firmly on the record with it for better or worse (which is to say whether I’m right or wrong): I think the US long-end needs rate hikes right now.
Rate hikes would anchor inflation expectations and tap the brakes on an economy that, according to the latest refresh on the Atlanta Fed’s popular GDPNow tracker, is expanding at a 5% clip.
As the text on the chart suggests, the current rate of expansion’s too fast, particularly to the extent it’s a function of robust demand.
The Fed’s playing with fire to countenance another episode of demand outstripping supply. The color accompanying the final read on Michigan sentiment for September suggested US households are pulling big-ticket purchases forward in order to avoid expected future price increases. That’s dicey.
In the same note mentioned above, Lyngen and Hartman cited “rising concerns that inflation becomes increasingly driven by overheating demand alongside persistent supply-chain disruptions” for the repricing at the front-end of the curve, which is more sensitive to Fed expectations.
Plainly, those expectations are embedded in long-end yields, but at a time when questions linger around Warsh’s commitment to the inflation fight and amid related concerns that the Fed’s independence remains imperiled, there are worse things for the long-end than rate hikes. Or at least that’s my assessment. (“Talk amongst yourselves,” Linda Richman says.)
Still, the history of the last six cycles does indicate that 10-year yields have upside from here. The increase during 2022/2023’s cycle — measuring from the meeting before the first rate hike to the peak in benchmark yields — was nearly 250bps. As BofA’s Michael Hartnett noted Friday, 10-year yields rose 260bps prior to the dot-com bust.
“Should the bearish momentum extend, the 2007 10-year yield peak of 5.322% is the next technical hurdle,” Lyngen went on. “A durable breach of this level would bring benchmark yields to their highest levels since 2002.”
