The bond-buying frenzy in the wake of hawkish tunes out of the Fed last Wednesday night caught everybody by surprise, to be fair. Pretty much gone are the pundits’ trains of thoughts that inflation would catapult long rates up further, have 10-year Treasury yields finally eclipse the 2% threshold and the 10/30-year differential move above 100bp, in an attempt to steepen the curve in line with this perception of a monstrous economic recovery.
Instead, the 10-year crashed back below the 1.50% mark, closing Friday out at 1.438%. That’s a long way from the top at the end of March, a good 30bp inside to be specific. And more importantly, the market is in a perfect medium-term formation of topping out. As this space has been musing for months, most recently
here and
here, the Treasury market’s resilience is here to stay and the 150bp area a ceiling area for the 10-year bracket.
What is even more astounding, however, is that the 30-year resoundingly outperformed the 10-year late last week. It rallied a whopping 20bp in the past two trading sessions alone and closed a full 50bp from the March high on Friday. The 10/30-year yield differential plummeted to 57bp, basically the stress level territory we were trading at when markets crashed in the wake of the pandemic in March and April last year.
In other words, the curve is flattening in every aspect and on every part of the curve, not only the traditional 2/10-year differential that has shrunk from 158 to 118bp but even across the long end. What is going on? What is the market pricing in here? Evidently as much as curiously, it is anticipating economic weakness. But aren’t we being told that we are right in the middle of the mother of all economic booms? Isn’t the inflationary spike another testament to it?
Well, inflation we might have, even though there is still the question about whether it will quickly moderate. Bonds are telling us either that this inflation is transitory, and the economy will weaken again after the current sugar high. Or we are being given a hint that inflation is here to stay despite a flattening of economic activity. It would constitute stagflation, a worst-case scenario for America, and the last thing the rest of the world needs coming out of the health crisis.
No one should be surprised, though. The Washington establishment, and particularly the Biden administration, have unleashed a tsunami of stimulus the world hasn’t seen. Adding up Trump’s measures last year, the 1.9 trillion relief package, and the infrastructure program that is to come, we are looking at a grand total of 5-6 trillion dollars, almost 1/3 of GDP. America is known to make big splashes to pull itself out of crises, but this is blatantly uncharted territory.
The imbalances emanating from this fiscal and monetary mania are and will be taking their toll. Any expectations for markets to play ball and perform in historical cycle patterns are in vain. The discipline of economics has irrevocably been rewritten since the financial crisis, I guess, when global central banks began to distort previous monetary balances for good. Bonds may have been declared an asset class of the past, but never call things too early. Let them buy bonds…
