US Treasuries were once again at the heart of market activity last week as the pressure on yields remained on the upside.
So far the Fed has deemed the move to be orderly and consistent with its economic recovery expectations, and from our perspective the main concern is still the pace of upward shifts in UST yields – last week it was fairly controlled.
We would now add another potential concern, which comes from the Fed itself. It does not appear to be listening to the market, which is potentially giving Treasury bears a free shot at the market.
As each week goes by we receive further good news on the economic recovery or new elements that might contribute towards it. Last week it was the pace of vaccinations in the US and the reopening schedules of several states; we had certainly not expected that all adults in New York could be vaccinated by the end of April, and US-wide by the end of May. This would surpass most investors’ expectations, and likely brings forward some of the positive economic outlook markets were forecasting for H2 into Q2, which could give us some significant data surprises versus current forecasts. Last Friday’s strong unemployment data (despite weather disruptions) suggested the return to work is now happening apace, and if this extraordinary cycle is anything to go by we may well see an upcoming employment report with one million US jobs being created.
Why is this important? In my view the Fed is too anchored in the present and is refusing to comment on the future. Markets are fully aware that over eight million jobs still need to be created to recover those lost to the US economy last year, and they are fully aware that the upcoming inflation is transitory. But markets are also fully aware just how fast everything has happened in this cycle so far. In fact, the only thing that has been slow is the Fed’s acknowledgment of this. With an additional $1.9bn stimulus package now approved for good measure, we would welcome some recognition from the Fed that should the economy recover quicker, stronger or in a more sustained fashion than it expects, then of course it would react if inflation risks were in excess of its tolerance.
One thing we do know is the Fed won’t be making any such comment this week, since its board members are in their blackout period ahead of the FOMC meeting on March 17. However, that also means they won’t be throwing fuel on the fire by suggesting they would be happy to let inflation run hot.
The week ahead is likely to be key for what the Fed does choose to say to investors next week, especially with such a large amount of fresh Treasury supply to be digested at the long end, with $38bn of 10-year notes and $24bn of 30-years up for sale in the coming days.
Our year-end forecast of 1.50% for the 10-year is already looking very out of date, and it would be a brave person right now to suggest that 2% won’t be touched any time this year as the recovery gets into full flow with the Fed holding its tongue.
Keeping duration short still looks the sensible play.