Interview
How Inflation and Fiscal Policy Are Driving US Treasury Markets
- The August 12th core CPI print registered 21.5 basis points, landing roughly at market consensus.
- The report's "read-through" to core PCE is viewed as softer than the CPI figure due to a weaker performance in the software sector, which carries a higher weighting in PCE.
- Forecasters are revising their inflation expectations lower following today's reading, though the Fed must still process a PPI report and September's inflation data before the next meeting.
- Bond market pricing now indicates a 9 basis point cut in the September Federal Reserve meeting, a level deemed appropriate given the remaining data to be released.
- Non-farm payrolls (NFP) last week showed negative growth, with 3-month and 12-month averages trending toward tepid levels of 20,000–30,000 jobs monthly.
- The unemployment rate has remained almost perfectly unchanged over the last 12 months, driven by immigration policy changes and an aging population rather than robust job creation.
- Mike Mitchell characterizes the labor market as "not that interesting," noting it is neither booming nor signaling a recession, and asserts it will not be a significant driver for the September Federal Open Market Committee (FOMC) decision.
- Inflation data remains the primary focus for the Fed, superseding employment metrics in the current policy context.
- Global fiscal paths are identified as problematic and likely to persist, driving increasing term premiums in the bond market.
- Following the July meeting, back-end Treasuries traded poorly after Chair Powell's dovish comments, specifically regarding the implication that higher long-term yields could substitute for policy rate hikes.
- The market is monitoring a potential shift toward a more hawkish central bank reaction function to provide comfort to longer-term yields.
- The August 10th 10-year Treasury auction yielded the highest level since 2007 and was smoothly digested, attributed partly to the softer CPI data.
- The 30-year Treasury auction is scheduled for the following day (August 13th), with market participants looking for a similar smooth digestion if the PPI print does not surprise to the upside.
- Heavy Treasury supply is expected to continue weighing on the bond market and driving term premiums higher in the coming years.
- Goldman Sachs projects Treasury issuance will focus almost exclusively on the front end and belly of the curve (up to the 10-year point), leaving long-end auction sizes unchanged.
- Corporate debt supply to fund AI infrastructure build-out is estimated at up to $250 billion for the current year and potentially $400 billion next year.
- This corporate supply dynamic aligns with heavy Treasury supply and fiscal concerns, creating a unified upward pressure on yields.
- Real yields on the 10-year sector currently sit near 2.5%, while 30-year real yields are approximately 3.0%, levels viewed as historically elevated relative to the post-Global Financial Crisis era.
- Historically elevated real yields are considered to offer value to long-term investors, contrasting with short-term investors who face headwinds regarding Fed rate decisions and supply dynamics.
- Treasuries are highlighted as providing portfolio diversification benefits and acting as insurance against growth shocks or recessions, despite periods of pro-correlation with risk assets during inflationary episodes.
- The recommended trade is a "steepener," betting on front-end yields anchoring to Fed expectations while back-end yields rise due to persistent term premium headwinds.
- A recession scenario is identified as a potential catalyst for significant steepening, though it is not viewed as imminent or likely in the near term.
- Key upcoming economic releases include the Consumer Price Index (PPI) for August 13th, retail sales data for Friday, and the July FOMC meeting minutes.
- Investors are specifically looking for insights into the committee's "temperature" and forward thinking regarding the September decision in the July meeting minutes.