Rates Spark: Escalating into a Rout as Bond Bear Steepening Accelerates
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Rates Spark: Turning into a rout
This bond bear steepening market is being driven by Treasuries, and more specifically by higher longer tenor real rates. This is painful for corporate borrowers, as higher real rates cannot be diversified away through higher prices (as could be the case if driven by inflation expectations). This puts pressure on credit markets as a result.
Too far, too fast?
It's messy out there. It's not often you get a 10bp uplift in the 10-year yield in one day. We had one yesterday. And we've had over a 50bp upmove in the past three weeks. It's now at 4.8%, and looking like it's gone too far too fast. But if we don't look down, that 5% level could be with us quite quickly. It's clear also that Treasuries are a dominant driver out there. It's pulling other yields higher, is hurting equities, and is pretty immune to influence from risk off.
Typically, a severe enough risk-off event would put some counterflows back into Treasuries. And there have been some. Right through the rise in yields in the past couple of months there have, in fact, been net inflows into Treasuries. But this has not been enough to dominate price action. In fact, prices have moved first, not so much in reaction to flows, but in anticipation of them. And of course in reaction to data that continues to show the US economy continuing to defy recession worries.
The JOLTS data are a case in point. This measure of "job openings" had been coming off the pandemic sugar high which saw them peak out in the 12 million area. A huge level. It compares with a long-run average in the 2.5 million area. It had been falling since mid-2022, and got to below nine million last month. But the latest month shows a pop back up towards 10 million (9.6m). That's a remarkable move in light of the inflation/rates/sentiment headwinds that arguably should be impacting the economy more.
And the curve continues to pull steeper (dis-inversion). As we ended the summer, the 2/10yr was in the -75bp area. It's now half that, and just 35bp away from breaking back above zero into positive territory. It's been pulled there by higher longer tenor real rates. The 10-year real yield is now knocking on the door of 2.5%, having been below 2% only a few weeks back. And importantly, inflation expectations are broadly steady. This angst mode has been driven entirely by higher real rates, and signs of underlying macro strength.
Note, however, that higher real yields are also more painful than ones driven by higher inflation. The latter can be passed on through higher prices at the corporate level. But higher real rates are more difficult to "pass on". They are essentially a tax on the borrower that must be paid to get any type of re-funding done. That is arguably where the next vulnerability lies. Risk assets are reacting to this, but there is the potential for more pain here ahead, especially in the guise of wider credit spreads.
Real rates are pushing higher
