Counterintuitive UST yield explanation

Not a lot of new insight after yesterday’s bump higher relative to our overall view so let’s take a look at a hot topic right now – whether the 10-year U.S. Treasury Yield has made a low and can move higher.  There is increased commentary in the financial press about the recent rise in the 10-year U.S. Treasury (UST) yield despite weaker economic data so let me take a minute to explain since it seems counterintuitive.

Remember that if the Fed eases they do so to stimulate growth, which should make long-term inflation expectations rise and in turn the long duration UST yields would also rise as they price in risk of increased inflation with the better growth outlook.  So if the Fed cuts rates and the 10-year UST yield goes up, the Fed and the markets are seeing eye-to-eye.  The opposite is true if the Fed is raising rates because they are doing so to slow growth, which should make long-term inflation expectations drop and subsequently that would be priced in to the market by lower UST yields.  So if the Fed hikes rates and the 10-year UST yield drops the market is also seeing eye-to-eye.

In our view, the markets get volatile when this transition mechanism is not working and the Fed is perceived to be behind the market.  For example over this year the Fed has been cutting rates, yet the UST yields have dropped and we have been frustrated the Fed is behind the market.  In our view, if the market believes the Fed cannot generate growth no matter how many times they cut rates the U.S. Treasury yields drop because it suggests sustained weakness that would lead to even lower inflation expectations and increase likelihood of a full blown consumer and manufacturing recession.  This has been the case over recent months, and despite Fed Chair Powell’s comments about using possible rate cuts to maintain economic growth the market hasn’t believed them, which is what happens surrounding a recession.

As you know, we believe the economy is set to emerge from the 3^rd mini-recession of the current cycle.  How do you know it is about to emerge rather than falling further into slower or even negative growth as highlighted above?  The 10-year UST yield stops going down and even begins to move higher despite weaker economic data, which has been the case since the September 3^rd low in the 10-year UST yield.

I hope this explains why the yield is going up despite weaker data and we are suggesting a more offensive field position.  Have a great day – Tony

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