The marking down of growth expectations given the increasing virus case counts from the delta variant across the globe has continued to pressure Treasury yields lower. Also contributing to the lower yields was the impression the Fed left on investors minds after its June meeting where they moved forward two rate hikes into 2023. The problem is now the Fed is in their quiet period before next week’s FOMC meeting so they can’t add new commentary while the market rapidly reprices growth prospects lower for the second half of the year. We think the Fed may well strike a different tone at next week’s meeting given they have been consistent in their messaging that the direction of public health will be the key factor in driving economic growth as we try and emerge fully from the pandemic. The confident tones about strong economic growth in June may be a little more tempered at next week’s meeting, and while there will be no update to the dot plots, reversing some of the newfound hawkishness from June may give risk assets a chance to rally, once again, and reverse some of the latest drive lower in Treasury yields.  Finally, in our podcast this week we go back and replay one of our most popular episodes Building a Better Culture with David Salyers, from Chick-Fil-A. If you missed it the first time or just want to refresh the lessons from David give it listen. The iTunes link can be found here and the Spotify here.

 

 


Treasury Yields Poised to Go Lower?

One of the features of the Treasury market after the June Fed meeting was with the moving forward of two rate hikes into 2023, the middle part of the curve repriced to a quicker pace of hikes with yields jumping on the revised outlook. As shown in the chart from Citigroup below after the FOMC meeting 5-year yields spiked to 0.95%. They floated around that level for days after the meeting as the market adjusted to the new Fed outlook. But as you can see as the calendar turned to July, yields started dropping as virus case counts started climbing once again, and second-half growth prospects started to be adjusted lower. The latest move lower this week has pushed yields below the range that had been in place since early March. The jump in yields off the June FOMC meeting expecting a quicker pace to rate hikes was short-lived as the new realities of increased virus cases reared its head once again.

The bigger question for the market is whether the latest health data has convinced the Fed that their June confidence in the economy and concerns over non-transitory inflation may be a bit misplaced? So far economic data is not showing much slowing in activity but consumer confidence is flagging from the recent jump in inflation so we are sure Chairman Powell will be looking for other signs of waning confidence, and perhaps slowing in hard-data given the increasing virus case counts. Powell is also a student of the market and it’s not lost on him the message it sends so with Treasury rates moving to lower levels not seen in months the tone of the Fed next week is likely to be a little less hawkish, and less confident then was the case in June.


TIPS Inflation Breakeven Rates Still Elevated but Trending Lower

The spike in inflation over the past several months was more or less predicted by the TIPS Inflation Breakeven Rates as shown in the graph below with both the 10-year and 5-year rates trending higher since the plunge lower during the initial pandemic lockdowns. They continued to climb right into April when the material price gains started to be seen in the monthly CPI numbers.

Source: Bloomberg

Since then, however, the breakeven rates have plateaued and recently started to dip some as the marking down of second half growth prospects also flows back into a marking down of future inflation prospects. It’s also notable that the shorter term 5-year inflation breakeven rate continues to be higher than the 10-year rate. That’s a feature that has held since January. Obviously, TIPS investors expect this recent run of inflation to be somewhat transitory as the Fed has repeatedly stated and to trend lower once the supply and demand pressures from reopening abate. While they both remain over the Fed’s 2% target, trending lower as they are should ease the nerves of some Fed members that have an itchy trigger finger on the rate-hiking button. We shall see if some of that outlook is reflected in next week’s FOMC meeting.


Agency Indications — FNMA / FHLMC Callable Rates

Maturity (yrs) 2 Year 3 Year 4 Year 5 Year 10 Year 15 Year
0.25 0.09 0.31 0.55 0.85 1.65 2.11
0.50 0.07 0.28 0.49 0.74 1.51 2.00
1.00 0.07 0.25 0.46 0.70 1.42 1.87
2.00 0.24 0.40 0.62 1.30 NA
3.00 0.57 1.24 NA
4.00 1.19 NA
5.00 1.15 NA
10.00 NA

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Published: 07/20/21 Author: Thomas R. Fitzgerald