Rates Steepen as Fed's Upgraded Dot Plot Takes Hold: 10-Year Yields Hit 16-Year High

Rates Spark: Steepening from the back end

The steepening via the back end has resumed as the Fed's upgraded dot plot sinks in. Even if the market does not fully embrace the Fed's view, the current discount for the Fed funds trough is high enough to justify 10Y yields of 4.5% and higher. EUR curve steepened from both ends, but today's German funding update may put the focus on the Bund asset swap spread.

 

The back end remains in the lead, in the US...

Bear steepening of curves resumed at the start of this week with the 10Y UST climbing  above 4.5%. As this marks the highest yield level in 16 years, the closer guideposts are relative valuations. The 2s10s curve for instance has just straddled -60bp, but we have seen range-bound levels for some time around -50bp post March this year. We would argue a key relative metric is where the 10Y stands in relation to the trough of the discounted Fed funds trajectory, essentially the Fed’s landing zone. If that stays around 4% then longer rates at 4.5% or even higher do not look out of whack.

The Fed’s key message last week was the shift higher in the fed funds rate projection. Even at the front end this change still has to sink in to a degree with the market discount of around 75bp still higher than the Fed’s 50bp. Of course this is all premised on nothing breaking in the meantime and data largely holding its poise. Therefore some scepticism seems only natural, but we have argued that it’s the long end that has more room to adjust relative to the given front end discount.

Which is why data in the wake of the central bank meetings will remain key, and this week has quite a bit to offer. Foremost the personal income and spending data later this week, but also alongside the Fed’s preferred inflation measure, the PCE deflator. Here our economist does see the risk of the monthly reading ticking higher again, similar to the upside surprise in the prior CPI release.