Bonds think the corner’s been turned

Bonds were tentatively set to confirm a peak in yields and runaway inflation in May, but a warmer CPI in the euro zone and the US prompted a final revision to the outlook. At the time, we discussed the possibility that the June 10 CPI data was a play in the wrong direction – an outlier in a data landscape that was indeed showing signs of a reversal.

The timing of the CPI was ideal for a misdirection play, as it happened on a Friday before Fed week, all at a time when the Fed had MOSTLY engaged in 50 point hikes. basis, unless the data suggests 75 basis points. CPI arguably did this, but the market was forced to wait for news from the Fed because they were in their “blackout period” (i.e. the typical 12 days before a Fed announcement during which the Fed refrains from publicly commenting on its policy).

Without the Fed to put things into perspective, markets priced in the most hawkish scenario. 10-year yields eventually hit 3.50% and mortgage rates climbed into the 6s. Once the Fed finally had its say, markets began to calm down.

Fast forward 3 weeks and early June looks even more like an explosion that puts out the fire. A series of almost universally weaker economic data at home and abroad added to the gains since Tuesday morning. Traders who made the mistake of shorting bonds in the latest apparent rally (Friday-Monday) have increasingly been forced to hedge, adding momentum to the rally over the past 2 days.

While this rally likely has short-term limits, it arguably confirms that we’ve seen the highest rates of 2022, barring an unforeseen shock to the inflation outlook.

Keep in mind that whenever 10-year yields fall 20 basis points before 11am (as they did to start the day today), a pullback is completely normal. The most important victory here is the decisive break below the 3% floor and the 3.5% relegation to the “distant memory” category. To be clear though, it still makes more sense to view the road ahead as a volatile, sideways range for the next few months. It would take at least that long for the Fed to start talking about defeating inflation (or rather, to start talking about how it would act on such a conclusion).

Garland K. Long