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).
Inflation concerns remain low at the end of the third quarter with the 10-year Treasury closing at 1.49%. This is just slightly higher than the 1.47% yield posted on 6/30/21. Looking out over the next few years, growth and inflation expectations in the above chart are tame. (source: Bloomberg).
Inflation concerns subsided in the second quarter. The first half 2021 Investment Grade Index total return of -1.06% was a sharp reversal of the first quarter’s -4.5% (source: CreditSights and BAML). The High-Yield Index resiliency strengthened with a first half 2021 total return of 3.70% versus the 90 basis point positive return for the first quarter (source: ibid).
Inflation concerns rocked the bond markets during the first quarter driving the Investment Grade Index down –4.5% (source: CreditSights and BAML). However, the High-Yield Index showed resiliency and posted a 90 basis point positive return for the first quarter (source: ibid).
The Federal Reserve’s Vice Chairman, Richard Clarida stated that “the development of several effective vaccines indicates to me that the prospects for the economy in 2021 and beyond have brightened and the downside risk to the outlook has diminished (source: Bloomberg news 1/8/21). He did caution that it would take “some time” for economic activity and employment to reach the peak level of last February.
Even with all the uncertainties created by the pandemic, third quarter GDP forecasts are up around 30%. The Federal Reserve’s Bullard weighs in at 30% (source: Wall Street journal 10/6/20), while J.P. Morgan forecasts 34.5% (source: J.P. Morgan Global economic outlook survey).
It has been barely 4-months since the pandemic lead to the shutdown of not only the US but most nations’ economies. The human and economic damage and suffering will continue for some unknown time.