U.S. 10-year Treasury yields are in a limp and lifeless season. They're looking to be justified by the dramatic data backdrop while evaluating and emulating every tick of the European stock market. But the fear seems to be the result of a lot of headlines without much new news – in other words, it’s not the miner’s canary and the doom will eventually lift and clear away.
Although U.S. fixed income markets are closed for the Columbus Day holiday, the abbreviated trading session on CMEGROUP’s globex have yields shaved yet another full basis point dropping to 16-month lows of 2.28%. Both momentum and technical traders contend far too much damage has been done to the Treasury market – leaving it susceptible to an episodic pullback; undoing the entire 2012/2014 yields rise. Recollections of early 2013, with yields hovering near 2.05% are now entering the conversation with seriousness and plausibility.
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The strength in U.S. 10-year Treasuries – hence, lower yields, was chiefly driven by the mixture of last Wednesdays FOMC minutes combined with the countless well-publicized macro-concerns. For the Fed, the mathematics has unquestionably gotten trickier. Although the U.S. September employment report was robust, persistent U.S. dollar strength combined with declining inflation expectations has abruptly turned grade-school arithmetic into calculus.
Add on top of that last week’s wayward European growth data – German Industrial Production, orders and exports along with the IMF forecast cut -- and, suddenly you have a Treasury market reinforcing the present negative sentiment.
Exclusive to last week’s market ecosystem was the brisk about-face of perceivable market drivers. Up through last week, with the exception of wavering global demand, markets were seemingly predicated on the notion that the U.S. economy has found a firmer growth track, driven by an upsurge in business investment and auto sales. U.S. industrial production has been spectacular and the Street was giddily penciling in a 3% GDP next year.
Traders pointed and compared today to historical parallels including the 1997 Asian currency crisis, 1994’s Mexican Peso crisis” and 1980’s Europe off-cycle recession, where the U.S. economic engine successfully tugged the train alone. The 2014 global growth sputtering would be just one more chance for the U.S. economy to successfully and singularly climb that steep grade. Instead, the present yield environment reflects a spotlight on international factors that weigh on recovery and might ultimately derail the ambitious upturn in the U.S.
Although fully acknowledging the countless headwinds surrounding us, I am convicted that U.S. Treasury yields will trend higher by year’s end. However, I don’t believe rates will be meaningfully higher – even if global economic data turns suddenly bright. Bear in mind, the U.S. fiscal debt is falling! This will ultimately result in less Treasury issuance going forward. Currently the U.S. Fed owns more than 40% of all long-term secondary Treasury securities – there will soon be a vacuum of quality long-dated securities that will keep U.S. rates artificially low. In addition, it looks like the market is miscalculating or overemphasizing the ECB’s ability or need to stimulate.
Perhaps consensus is coming to terms with the quagmire of solidifying nations, politics, incentivizing banks to lend while simultaneously deleveraging, creating a blueprint for inflation in a disinflationary environment, and whatever else can be conjured up on the news wire.