Groundhog Week! Last week was another brutal beatdown in the rates markets as the 30-year Treasury bond broke through 5% since the first half of 2007 on Friday. As I said last week, the sell-off in the rates market has become quite disorderly. Certainly, monetary policy and economic conditions are still important, but I feel the main driver is the bottomless cup of sovereign bond supply. When rates were near zero, deficits mattered optically but the pain was not yet present. Now deficits are growing exponentially and borrowing rates are triple what they were in the first quarter of 2022. From the demand side, domestic bank buying has and will continue to slow sharply as borrowing rates increase and excess reserves at the Fed drain away. On the foreign buying side, currency hedging costs have risen substantially along with the value of the US Dollar. Couple that with China’s many domestic credit issues and you have what we are seeing now, real rates in the mid-2%s. Meanwhile, the employment situation continues to show strength as Friday’s release of the September payroll report came in much stronger than expected, sparking a huge, end of week selloff.
We come into a holiday shortened week with Treasury yields significantly lower as a strong flight to quality trade began overnight in reaction to the war in Israel-Gaza. As events unfold in this conflict, I expect strong market reactions, however I think the flight to quality bid will be successively less and less. Over the weekend there was a good amount of “Fed speak” with the prevailing message being that perhaps the Fed can allow the latest spike in real yields to replace further tightening. Perhaps. The big economic data event this week will be September CPI on Thursday.
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