REVIEW ON THE PAST WEEK
In the week just past, the Treasury market had a few key data points from which to refine forward expectations. The most relevant one on the economic data front was the disappointing core CPI print for the month of January. In January, core consumer prices were effectively flat. In addition, the Treasury market had to contend with the refunding auctions that was $58 billion in threes, which stopped through two tenths of basis point, $41 billion in new tens, which stopped through three tenths of a basis point and $27 billion in thirties, which tailed one basis point.
Post-refunding Treasury yield
One might be tempted to interpret the results of the long bond auction as a sign of a lack of sponsorship for Treasuries further out the curve. However, refunding 30s, not re-openings have a very strong tendency to tail, having done so now at 9 of the last 11 refunding auctions. This leaves us reluctant to interpret those results as anything more than strong, ongoing sponsorship for duration in the Treasury market. If nothing else, we learn that there’s a potential for reasonable domestic sponsorship for 10-year yields above 1.15. Now whether or not that translates through to the establishment of a new upper bound for 10-year rates at 1.20 remains to be seen. We’ve been focused on what from a technical perspective appears to be a double top. And that’s a double top between 1.19 and 1.20, not textbook, but close enough that it suggests the current period of consolidation might ultimately resolve in lower rates.
Reflation
The Treasury market is trading off of inflation at this point in the cycle than for trading off of the manufacturing sector data, or to a large extent ignoring the employment report. While the distinction between realized inflation and inflation expectations and the divergence that we have seen thus far in 2021 is an important backdrop as we think about the market going forward. We could very easily see the real inflation data continue to struggle as the year plays out, but inflation expectations remain high. It’s also important to keep in mind that headline CPI is heavily weighted toward the energy sector and gasoline prices. And the moves in the energy complex really adds some staying power to this rally we’ve seen in breakevens. Both five and 10-year breakevens are above 220 basis points. And while the underwhelming CPI read should on the margin detract somewhat from those expectations, the fact that we’re seeing such a meaningful pickup in crude and gasoline prices really limits any potential downside should we see a reversal.
Another key distinction is between goods inflation and service inflation. Given that the consumption patterns created during the pandemic have favored goods consumption over service consumption, it makes sense that there was upward pressure on goods prices where flagging service sector inflation became the norm. Fast forward to the second half of 2021, once the economy is reopened and re-engaged in in-person commerce, the baseline assumption for market participants at this point is that we ultimately will see more upward pressure on service sector consumption and inflation to follow.
Fiscal Stimulus
One of the background macro-factors in the market at the moment is the ongoing progress towards stimulus. It’s worth highlighting the results to our pre-NFP survey, which revealed a consensus around market expectations for the ultimate size of the fiscal deal. The most common response was between $1 and $1.25 trillion. But just as interesting, was the fact that no one thought no deal was going to come and no one thought a deal below $500 billion was going to come. For the question how much will the 10-year yield respond to a stimulus deal when it’s finally announced, using that one to $1.25 trillion consensus, anything either materially above or below that will trigger a price response in the Treasury market.
All About Macros 