Bearish Pressure Persists: US 10-Year Yield Approaches 4.25% Amidst Unconventional Curve Movements

Rates Spark: Bearish structure still

The US 10yr hit 4.2%. It's likely to hit 4.25% and then 4.3% in the coming weeks. Watch the 10yr continuing to cheapen on the curve. It's unusual for that to happen at this stage, but that is what's happening. Oh, and the US 5yr*5yr inflation rate is almost at 2.8%, and still trending up. Not great.

 

The structure of the US curve continues to trade in a bearish fashion; don't fight it

The US 10yr decided to touch 4.2% again, the second time in a couple of weeks. We continue to view the 10yr with a 4% handle as comfortable, and with little immediate hope of breaking back below 4%, the path of least resistance, for now, is to test higher.

 

The next obvious target to aim for is the prior cycle high at 4.25%, and the intra-day spike to 4.3% back in March. The 10yr is now above the yield highs seen just before Silicon Valley Bank went down, while the 2yr is approaching its prior high at that time (around 5%). So the main difference between now and the pre-SVB demise period is the curve today is less inverted, primarily as the 10yr yield is higher.

It’s unusual as long tenor yields have typically tended to fall as the Fed peaks. In consequence, the curve is trading in a manner that questions whether the Fed has in fact peaked, and if the Fed has peaked, the market is openly questioning the extent of subsequent cuts. When SVB went down, the market was discounting a future funds rate at close to 2.5%. Now it’s barely discounting a funds rate much below 4%. That is a key difference and continues to limit the room for longer-tenor yields to fall.

In the long bond area, the 30yr remains in the 4.25% area, and the interesting move here has been for the 10yr yield to rise relative to it – hence the 10/30yr spread has been flattening. Typically this would steepen as the Fed peaks, with the 10yr yield falling relative to the 30yr. That’s another difference in play. Less inversion on the 2/10yr segment and flattening on the 10/30yr segment has the belly cheapening on the 2/10/30yr combination.

That too is unusual at this stage of the cycle. But we also expect it to continue some more.

And by the way, the US 5yr*5yr inflation swap rate has spiked to 2.78%. That as a stand-alone number is troubling. It was at around 2.5% at the beginning of the year, and has slowly journeyed back to get uncomfortably close to 3%. It's volatile and reflective of steepening in the inflation swap curve. For as long as it's trending higher, it is in fact tough for the Fed to pack away its rate-hiking kit with any degree of conviction...

 

US curves are not showing the typical end-of-cycle vibes

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Today's events and market view

Rates remain exposed to upward pressure near term, one reason being brewing inflation concerns. UK wage growth has surprised to the upside this morning. We think the reason that especially long-end yields have not risen further may be owed in part to a more fragile risk sentiment as markets are eying the recent developments in China, including its property sector, with greater concern. The latest activity data released overnight contained no bright spots, and quite a few downside surprises, as our economist notes, prompting the People's Bank of China to ease.

The main data release later today will be the US retail sales. It is seen posting a decent figure thanks in part to Amazon Prime Day lifting spending, higher gasoline prices boosting the value of gasoline station sales, and vehicle sales ticking higher. With inflation dynamics in focus, import prices should also see some attention, especially given the unusually large reaction to last Friday’s PPI figures. The Empire Manufacturing report rounds off today’s US releases.

While the US economy continues to display resilience, the German ZEW release today will highlight the concerns around the German economy being stuck in a twilight zone.

In supply, Germany sells €5.5bn in the 2Y Schatz.