Good Wednesday AM (still the best day of the week),
The morning did not start off well for bonds. The 10-yr pushed to 1.42% which, if you are a chartist (which I am not but, I do like to steal their data), was the next line in the sand. It is incredible to me that we have seen the 10-yr yield rise 90 basis points in 4 months. The things about lines in the sand is they are like a levee. If they hold, the waters have a chance to recede. If they don’t, well, there is a lot of clean up to be done. In this case, if it did not hold, we would be looking squarely at a 1.50 10-yr yield. Fortunately it held and the 10-yr has retreated to 1.39%. The bigger picture though is where mortgage bonds started the day off in the red by another 25bps, we are now back to even. Yes. I will take even as a win today. Back to the chartists, which despite today’s mini reprieve, show further selling when the bounce is complete (rut row). So today’s point is to lock into the improvements and not to wait for more. You may be disappointed.
Bloomberg has been doing a terrific job of late discussing bond market movement, trends, causes, and outcomes… here is another post from today:
Rates on Treasuries have been rising lately, and with Jerome Powell up on the Hill, there’s growing chatter on whether there’s some problem emerging. Is the Fed losing control of the curve in some way? Is the market testing the Fed’s credibility in its fight for higher inflation and maximum employment? There are lot of takes out there, so be careful.
The three month-three year U.S. yield spread is basically a measure of how fast the market expects the Fed to raise rates over the next three years. When the number is high, the market is pricing in several hikes. When the number is low, the opposite. In the wake of the Great Financial Crisis (the red shaded area in this chart), the spread got as high as around 150 basis points.
Think about what this means. In the midst of a historic collapse, the market was pricing in numerous hikes between 2009 and 2012. Now we know, in retrospect, that the Fed didn’t start hiking post-GFC until the end of 2015. So there was just an incredible mismatch between expectations for what the Fed would do post-Lehman and what it actually did in practice. Now, fast forward to today, and the spread is less than 20 basis points. Which means there’s not even a full quarter-percent hike expected. Maaaayyyybe we’ll get one hike over the next three years according to the market. Maybe. But also again, consider that we’re expected to have blazing fast growth this year and next. Goldman has us growing at around 7%, which would be the fastest pace in years.
So here we are with a reopening, stimulus, solid household balance sheets, and the expectation of red-hot growth, and still the market doesn’t really see any hikes before 2024. If you thought that maybe the market was testing the Fed, or skeptical of its credibility, this should put all that to rest.
Please remain safe and healthy, make today great.