Following the latest barrage of opinions from Wall Street pros on the “magic number” – i.e., the level of 10Y Treasury yields which would cause traders to rotate from equities into bonds…
… here is Bloomberg’s markets commentator, Garfield Reynolds, who in his latest Macro View takes a slightly more fatalistic approach, predicting that no matter what the threshold is, yields are now set to overshoot to the top, noting that “the Treasury yield eruption so many have feared looks likely to come soon” and predicting that the concern is that “other markets aren’t prepared for the sort of sustained and substantial sell-off in Treasuries that hasn’t been since for decades.“
His full note is below:
Treasury Yields Set to Overshoot to the Top for Once: Macro View
The Treasury yield eruption so many have feared looks likely to come soon. The concern is that other markets aren’t prepared for the sort of sustained and substantial sell-off in Treasuries that hasn’t been since for decades.
Much of the latest move that sent 10s above 3% has been seen as driven by technicals after being initially triggered by a jump in European yields.
That’s a worry because the market has now gone past a series of strong resistance points without significant reliance on a scary set of economic fundamentals — rising Fed rates, ballooning U.S. deficits, fiscal stimulus, accelerating gains in CPI and crude oil.
Even with the Fed’s implicit confidence that the deflation dragon has been slain, the bond market is in danger of underpricing CPI gains. Five-year breakevens are rising but they have been overtaken by both headline and core inflation figures.
That’s come as crude oil ratchets up in price, overwhelming such long-term bear factors as changing energy-usage profiles and U.S. shale oil production. While recent rallies benefited from unhealthy geopolitics, crude has stayed buoyant even as global tensions eased. That keeps bond traders edgy for signs of fresh inflation acceleration.
It also helps explain why the term premium is back on the move — on pace for the steepest monthly jump since Trump’s November 2016 election.
There’s plenty of scope for the term premium to keep going as the Fed moves to lessen its repressive sway over the market — ongoing balance sheet reduction, a Fed benchmark rate getting closer to inflation, and the growing chorus calling for an end to the dot plot.
That all removes certainty, boosting the term premium and volatility.
That rising Fed rate is also creating what may be the single biggest upward driver for Treasury yields — the jump in money-market rates. They’re on the verge of offering real returns, and beating stock dividend yields, at a time when the Bloomberg Barclays index of T-notes due in 10 years or less is heading for the first 3-quarter losing streak in its 45-year history.
That helps explain why some of the brakes that slowed or stopped previous sell-offs aren’t working — despite some of the biggest yield premiums on record, foreign holdings have stalled and demand is soggy at auctions. The surge in the dollar seems not to be feeding into bonds and is only intermittently driving stocks, while flows into cash and money market funds have been strong.
It all adds up to a reduction in the haven allure of Treasuries and increases the odds for an unusual overshoot to the top side for yields, one that can devastate a whole range of other assets.