U.S 10-Year Treasury Yield Eyes 3%
The United States 10-year treasury yield has gone from 2% to almost 3% in a few month and ING Economic analysts are skeptical whether the norm is done.
Back in February, the U.S 10 year broke above 2%, and ING analysts had posed the question – now what?
ING Economic analysts noted at the time that “a tame 25 basis point hike from the 16 March FOMC with no bite could leave the market at least pondering a path towards 3% on the 10yr”.
“Well here we are; now knocking on the door of a 3% 10yr yield as we face into the next FOMC meeting set for 4 May”.
“We think there are two possible states ahead. One is for things to become more explosive. The other is for things to calm down. The latter is more probable, but the former is entirely possible, depending on a few important factors”.
What the Federal Reserve does next is important for starters. A 50bp hike is fully discounted from the 4 May FOMC, but there is a mild discount brewing for a 75bp hike, ING said.
The minutes of the March FOMC meeting were remarkable in the sense that members noted that a 50bp hike could have been on the table had it not been for the Russian invasion of Ukraine.
This is important as it is quite rare for the Fed to even consider delivering something that was not pre-discounted by the market -even if often pushed there by the Fed in the first place.
In consequence, the argument goes, could the Fed deliver 75bp in May as a catch-up? The argument against a 75bp hike is it could cause more consternation than comfort. We still think they do 50bp, but watch this space all the same.
The big question centres on inflation expectations – can they be contained? In contrast, the argument in support of a 75bp hike centres on the containment of inflation expectations.
Last week, the market saw the US 10yr inflation breakeven briefly break above 3% (it’s back below now). Psychologically it’s important for the Fed to keep 10yr inflation expectations below 3%.
Long-term inflation expectations are tolerable with practically any kind of 2% handle, but intolerable with a 3% one. Remember, elevated 10yr inflation expectations are absolutely not about contemporaneous supply-chain bottlenecks or energy price spikes.
Rather, it’s about a failure to anchor long-term inflation dynamics, an area of central responsibility for the Federal Reserve. For as long as inflation expectations are testing the upside, it’s hard to argue that we are at a turning point for market rates.
“We are on turning point watch – close but not there just yet. Typically, we know there has been a turning point in market rates when we see it in the rearview mirror”, ING said in a commentary.
Analysts argued that turning points typically occur when the 2/5yr spread is flattening with the 5yr yield falling, adding to that a requirement for inflation expectations to peak out and start to fall.
That, together with a richening of the 5yr on the curve, would provide the key ingredients for market rates to top out. Right now, the 5yr is too cheap, and crucially inflation expectations are still heading in the wrong direction. So the pressure remains for market rates to head higher still. #U.S 10-Year Treasury Yield Eyes 3%
