In our previous letter in January we noted that the trend to lower inflation and interest rates will be bumpy as it usually is. The consensus then pointed toward lower yields ahead driven by perceptions of a slowing economy both here in the U.S. and abroad.
Since the bond market low in mid-October 2023, a strong rally ensued. The 10-year Treasury yield fell from 4.99% to 3.79% on December 27, 2023 (source: Bloomberg 1/17/24). Investor’s expectations of future interest rates drive the market.
With interest rates reaching levels not seen since since 2007, divergent outlooks are increasing. On the one hand, a recent article noted that some money managers are betting against the corporate and high-yield bond markets by shorting the larger and more liquid exchange traded funds (source: Bloomberg
10/16/23).
The Federal Reserve’s aggressive campaign to reduce inflation to its acceptable target of 2% is clearly bearing fruit. Earlier in July, on 7/7/23, the Bureau of Labor Statistics reported declining job growth with nonfarm payrolls increasing 209,000, below consensus estimates.
”Since the full impact of monetary policy actions can take as much as 18 months to work its way through the economy, we will continue to look closely at available data to determine what, if any additional actions we may need to take.” (Patrick Harker, Philadelphia Fed 4/11/23 source: Bloomberg)
“It may be a mild recession. It may not be.” (Jamie Dimon, JP Morgan Chase CEO on a call with reporters as reported in The Wall Street Journal 1/14/23)
The recent hotter than expected jobs data sent the Dow Jones Industrial Average down over 600 points on Friday, October 7. That day the 10-year Treasury note yield rose to 3.88% and reached a multiyear high of 4.03% on October 14 (source; Bloomberg 10/18/22). Investors continue to react negatively to strong jobs data that will cause the Federal Reserve to continue its aggressive interest rate increases to battle inflation.
So, what drives investor interest in the 30-year auction and longer maturities? They might be measuring the impact of present day Fed rate and monetary actions on future economic activity and inflation. Some strategists see the 2-10 year curve inversion signaling a recession. The 10-year Treasury yields 2.92% while the 2-year Treasury yields 3.14%, today (source: Bloomberg 7/13/22). The curve is inverted the most since August of 2000 (source: ibid).
“This is not the kind of inflation from the 1960s and 70s” (Chicago FED president, Charles Evans 4/11/22). During that event before the Detroit Economic Club, Evans contended that the current spurt in prices is temporary, rather than sustaining and that inflation will revert back to pre-pandemic levels in a year or two (source: MarketWatch 4/13/22). The chart on page three shows the longer period, five to ten year inflation expectations of surveys by the University of Michigan remain subdued at about three percent.
Inflation outlooks show near term increases, but significant declines as the economy normalizes, moving beyond the abnormalities generated by the pan-demic. At the end of the 4th quarter the 10-year Treasury closed at 1.51%, an insignificant increase from 1.49% at the end of the 3rd quarter. Looking out over the next year, the chart above shows inflation expectations on a steady downward decline. (source: Bloomberg).