Today is the last day of the month and quarter. That means more for financial markets than it does for many other sectors. While there is no hard and fast rule concerning timing, there is historically increased trading activity at the end of month (and quarter) as various types of money managers rebalance their portfolios or adjust their holdings to match underlying benchmarks. Read more about the Treasury/MBS specific month/quarter-end considerations HERE.
In other news, Biden is expected to speak at 4:20pm ET today with more details on the infrastructure plan. This is late enough in the trading day that it’s more of a consideration for tomorrow (and even then, most of the details have already trickled out). In fact, it’s fair to say that a good amount of the bond market weakness of the past 6 months has included the assumption that some combination of stimulus/spending would account for several trillion dollars of additional bond market supply.
Bond market supply is “bad” for rates. Higher supply = lower prices = higher yields, all other things being equal. It’s actually a double whammy in the case of covid relief and stimulus/infrastructure as that spending would ideally promote a stronger economy and higher inflation–two other things that are “bad” for rates.
Just how much of our fate is in the hands of inflation? This is a very popular narrative right now, and in general any time rates are rising (or at the risk of rising). Inflation is certainly important to bonds, but is it perhaps more important than it should be due to lingering trauma from 70s/80s-style hyperinflation? Almost certainly! That’s been one of my key talking points in the past 15 years as inflation has remained in check despite episodes of panic.
If there were a time for inflation to make a meaningful comeback, 2021-2023 is the best chance we’ve had in decades due to the combination of supply side constraints and fiscal/monetary easing. That’s the foundation of the inflation thesis anyway. I don’t necessarily agree with it as there are other factors that continue to push back in a disinflationary direction. Ultimately, all that really matters is reality (go figure) and how traders are trading it.
With that in mind, let’s look at a few charts that can help us make sense of inflation vs rates in 2020/2021. Each chart contains 2 lines. The blue line is “inflation expectations” based on the yields of inflation-protected Treasuries or TIPS (technically the spread between TIPS and the 10yr yield, aka “breakevens,” for the market geeks out there). All you need to know about the blue line is that it shows how traders are actually betting on inflation over the next 10 years. The yellow line is simply the 10yr yield itself.
NOTE: in all cases, the charts are showing the CHANGE from a certain date. As such, the “-.0672” for the 10yr yield in the first chart does not, in fact, mean that 10yr yields were ever -.0672, simply that they are 0.0672 lower than they were on the specified date (1/1/2020 in this case).
To be sure, inflation expectations were WELL ahead of the rise in yields in 2020. A case could also be made for the little pop in December leading the 10yr’s similar pop at the beginning of January, but if you are a regular reader, you know that was all about the GA senate election. You might also already be noticing that the yellow line seems a lot steeper in 2021 in general. If so, the next 2 charts won’t be a surprise. We’re simply going to choose different start dates to emphasize the discrepancy. Let’s start with April 2020.
That makes it even easier to see, but we can do better. How about January 2021?
Bingo. Now the yellow line is above the blue line and we can see a clear jump in mid February for 10yr yields. If we go back to Feb 16th and look at the MBS Live huddle, we find the following: “US stimulus on track to be bigger than expected.” That was also the week following the conclusion of the impeachment trial which allowed the senate to move on to approving the $1.9t stimulus package. In other words, we had $1.9t sooner than expected and talk of additional stimulus followed only a few days later.
Bottom line? The charts and the news make a strong case for TREASURY SUPPLY being a key driver. Unfortunately, it’s difficult to fully separate from the COVID narrative because case counted were plummeting to the bottom of their range on the same week and vaccination counts were ramping up. Either way, we can say this: trading levels do not yet suggest inflation has shown up in a scary enough way to be responsible for the rate spike in Feb/March. The takeaway is that a leveling-off or decline in inflation in the future would be limited in terms of its ability to promote lower bond yields. The bigger benefit would be a drop in supply.