Bonds enter the 2nd day of the week without any major reprieve in the selling trend. That trend kicked into a higher gear yesterday, prompting us to discuss big-picture, fundamental drivers. Global central bank tightening and increased bond issuance were two of the key themes that corresponded to the biggest moves in rates, but there’s another ingredient lurking in the shadows. Lately, the menacing sounds of inflation have been growing louder (from the shadows, even!), leading bond traders to fear its imminent return.
Naturally, with economic data humming right along, $1.4 trillion in tax bill spending, and more infrastructure spending plans to be announced at tonight’s State of The Union, inflation is a logical concern. Bond markets have a way to price its effects in real time via TIPS trading (Treasury Inflation-Protected Securities). These offer traders an inflation-free 10yr yield which protects them against rising inflation. By subtracting TIPS yields from regular old 10yr yields, we get the market’s inflation expectations (aka “TIPS breakevens”).
Breakevens have essentially led the move higher in longer-term bond yields both in the short and longer-terms. This can be seen in the blue line on the chart below. Notice how it has been the general driver since the middle of 2017 and a specific driver since the middle of December. It’s also worth pointing out that inflation-free yields haven’t done bonds any favors in the past week as they moved to the top of their longer-term range (this looks more meaningful in the short-term chart on top, but more like an in-range move in the longer-term chart on the bottom).
With all of the above in mind, we’ll be waiting until the 2nd full week in February before getting the next installment of the Consumer Price Index (the inflation report that’s garnered the biggest reactions over the past 7 months). But there are several inflation-related tidbits between now and then. We’ll be watching these closely to see how much markets are refining their outlook based on data. If we don’t see big reactions, we’re left to conclude that traders are pricing in inflation that has yet to occur but that they figure will probably occur based on the econ data combined with government spending.
One final takeaway from the chart above is this: notice on the lower chart how neither the blue nor red lines are definitively above their 2017 trading ranges. Granted, they are both pushing the upper boundary, but not clearly breaking out. That means the breakout in 10yr yields only looks like a breakout because the two components are in bad shape at the same time. This isn’t to say that yields shouldn’t be in bad shape or are due to reverse in grand fashion. Rather, it suggests that 10yr yields can be viewed as being in the upper limit of their 2017 range, even though they’ve visually broken higher. It’s sort of a caveat to how bad yields look on an outright basis. Bottom line: I wouldn’t be anything other than defensive in terms of locking/floating, but I also wouldn’t abandon hope for a corrective bounce just yet.
MBS Pricing Snapshot
Pricing shown below is delayed, please note the timestamp at the bottom. Real time pricing is available via MBS Live.
100-32 : -0-02
2.7124 : +0.0134
|Pricing as of 1/30/18 9:33AMEST|
Tomorrow’s Economic Calendar