The rulebook
Last week was shorter than normal in the US but incredibly volatile nonetheless. The rulebook was torn apart, leaving investors chasing their tails. Better economic data? Who cares, it has peaked. Inflation? Who cares, it is probably transitory. Interest rates going up? Who cares, it means less inflation risk in the future.
The big question this week has been why US Treasuries have been rallying in the face of heightened inflation and more robust growth. It doesn’t really matter what one thinks about peak growth or transitory inflation – should Treasuries be rallying with equities and where should they really trade at this point? Real yields are incredibly important, and as we have moved in a more negative direction, inflation expectations have dropped significantly.
Are we really at the beginning of a new cycle, or was the COVID crisis merely an interruption of the last cycle? This distinction is important for one’s outlook on the economy. It would seem that the Delta variant is signalling less growth, additional quantitative easing (or at least no tapering) and more government bond buyers.
Is it back to the Goldilocks Scenario?
When we reached 1.80% on the 10 year US Treasury just a few months ago, we were talking about how far over 2% the 10-year would reach. Now the narrative has shifted back to when we reach 1% again. Market consensus is reflecting that a slowing economic recovery, combined with the fears over the Delta variant, means less tapering. Some of this is contradictory but that doesn’t seem to matter at the moment. There are obviously wider implications for the US dollar and risk assets – and it seems like we are back to the Goldilocks scenario.
According to Bloomberg, 10-year treasury yields declined for 8 straight days and that has only happened “just a handful of times in the past two decades”. A 9-day decline has not happened since March 2000[1].
Interestingly, the only thing to stop the downward pressure on yields was new 3 and 10-year supply on Monday this week, when $38bn[2] arriving into the market was enough to reverse the trend, at least in the very short term. Even the latest numbers released on the US Consumer Price Index (13/7/2021) was seen as transitory – used cars yes, but is lodging transitory. It does look like the market is increasingly removed from what is going on in reality, but with limited supply and a continuation of buying by the Treasury, there have been strong technicals behind the move. The question remains whether we will now see a gradual move back to a more normal level even if we have seen peak growth.
From my perspective, 2% on the US Treasury 10 year seems very far away, but we are maintaining our more conservative positioning for now. At 1.35% yield on the 10 year, in the face of higher inflation and into what looks like a robust earnings season, we continue to view the opportunity in Fixed Income in carry.
[1] Bloomberg, 13 July 2021
[2] Bloomberg, 13 July 2021
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