A funny thing happened on the way to the expected 2% 10yr yield in the second half of 2021. It hasn’t happened yet, and it doesn’t look like it’s going to happen anytime soon. Remember the story early in the year was that with the vaccination roll-out going well, and service-related businesses reopening in larger and larger numbers that the second half of 2021 was poised to post some big numbers. Well, with vaccination rates slowing without reaching the expected population coverage in many areas, and with the delta variant threatening the timeline for a return to normalcy, and the fading impact of fiscal and monetary stimulus,  the market is thinking perhaps that the peak economic numbers may already be behind us. We explore in more detail below some of those thoughts and what that may mean for yields as we move through 2021.


How Low Can Yields Go?

Today, we are showing the 10yr Treasury yield below against various moving averages and Fibonacci lines to see what the next line in the sand might be in relation to how low yields can go. We mentioned on Wednesday that yields were threatening the 1.40% bearish resistance line that had held since the August lows, and yields did indeed dip through that resistance contributing to further buying as shorts were forced to cover.

 

Source: Bloomberg

As the graph shows, in June the Fibonacci line at 1.46% was popular resistance but once it gave way the drop was on. There was a brief pause around that 1.40% August bear trend resistance, but once that broke on Tuesday that gave way to another dip. From here it looks like the 200-day moving average of 1.23% may provide some resistance to further dips as you can see both the 50-day and 100-day average provided some minor resistance before giving way. So what is causing this dip in yields despite good to strong economic results? Partly, it’s the aforementioned short-covering but other factors are at play as well. Given the limited reaction to CPI and jobs numbers the market is likely looking past near-term numbers as too noisy to glean much actionable information. They are definitely buying into the Fed’s transitory inflation story for the time-being, and with the recent FOMC meeting pulling forward two hikes into 2023 they are also betting the Fed will not be so sanguine after all about inflation above 2%. Finally, investors probably consider “peak economy” has already occurred as fiscal and monetary stimulus starts to fade and the emergent delta variant virus is starting to threaten the timeline to economic normalcy.  In the end, a clear catalyst for higher rates appears missing at present while a stopping point to lower rates doesn’t appear clear either.


Treasury Inflation Protected Securities Breakeven Inflation Rates Continue to Drift Lower

After taking a look at the dip in nominal yields, and exploring possible landing spots, we turn our attention to what has been going on in the inflation expectation space in the form of TIPS Breakeven Inflation Rates. Recall, that much of the 2021 trade in the first quarter consisted of rising rates on the back on gathering inflation expectations. The breakeven graph below shows that those expectations actually started rising almost as soon as the lockdowns commenced and the first stimulus packages were introduced into the economy.

Source: Bloomberg

It was pretty much a one-way trade until April and May of this year when some loss of momentum was noted and breakeven rates started to pause and then decline. Despite some historically high CPI prints, breakeven rates stalled out in April and May and decisively headed lower in June. Investors, seeing the supply-driven price spikes and still slow-recovering labor market, seemed to have bought into the Fed’s argument that most of these price increases will be transitory. This drop in inflation expectations is another reason for the decline in nominal rates and should the dip continue, it will work to drive nominal yields even lower.


Agency Indications — FNMA / FHLMC Callable Rates

Maturity (yrs) 2 Year 3 Year 4 Year 5 Year 10 Year 15 Year
0.25 0.10 0.32 0.60 0.93 1.75 2.21
0.50 0.09 0.29 0.54 0.82 1.60 2.10
1.00 0.08 0.26 0.50 0.77 1.51 1.97
2.00 0.25 0.45 0.69 1.40 NA
3.00 0.65 1.33 NA
4.00 1.29 NA
5.00 1.25 NA
10.00 NA

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Published: 07/08/21 Author: Thomas R. Fitzgerald