With all of the drama surrounding the Presidential election coming up in November, people may have missed the bond market trading off to four month highs in yields. If you did miss it, it's probably due to the fact that mortgage rates have not tracked closely with Treasury rates and have moved very little. Today the US 10yr is at 1.75%, its highest level since June 2nd and could push to 1.90% before November at its current pace.And it's not just the 10yr, the entire Treasury stack from 2yrs to 30yrs are at 4 month highs. The main cause of this move upward is inflation expectations and the Fed. The market has grown more comfortable with the belief that inflation is moving higher along with a Fed determined to move rates as soon as possible.
The GDP price index came out at the end of September at 2.3% and QoQ Core PCE (quarter over quarter personal consumption expenditures) was at 1.8%. The Fed's 2% target is within range. In the next week PPI and CPI will be released which could push yields up further or completely reverse the trend and send the Fed reeling for an explanation. Make no mistake, the Fed wants to raise rates. The market is banking on December with a 68% probability versus 17% for November. Recall in July the odds of a December hike were about 10%, so there has been a material shift in future rate expectations for year end.
If you are tired of reading about the election, skip this paragraph. It's very doubtful we will see a Fed move in November given the circus around the election. Do you think the market trades based upon who they expect will win? Indulge me if you will: before inflation figures came out the 10yr was trading at 1.58%. GDP, the GDP price index and Core PCE all came out on Sept 29th, with the 10yr closing at 1.56%, down 2bps. On September 30th, the month over month PCE deflator along with personal spending and personal income came out, and the 10yr traded at 1.59%. The market is basically flat after all of the Fed's preferred inflation gauges were released. Fast forward to the next week, prior to Friday's payroll number there was no significant market data, instead what flooded the news were Donald Trump's taxes as well as other story lines related to him. The 10yr rose 14bps well after the inflation figures, which had no impact and before non-farm payrolls report. On the day of non-farm the 10yr actually dropped 2bps. Now post non-farm and following the second debate the 10yr is up another 5bps (without any economic news). The market is saying rates are up because of inflation, but is it inflation or a growing belief that Hillary Clinton will become President? It's not to say rates will go up with her in office but certainly the market believes the Fed will move faster if she is elected. It is likely that the inflation figures confirmed people's beliefs that the Fed will move and with Clinton the likely victor in the election, it gave the market some relief. Basically the market would have sold off after inflation came out but only if there is more certainty in the election. Notice how the market is waffling.... Inflation, the Fed's immediate gauge of an interest rate rise doesn't move the market but more certainty around the election does? Will there be a reversal?
Hard to say what the market is going to do next without knowing what will happen next in this crazy election. Just a reminder that fear drives bond purchases and calm chases them into riskier assets. Personal opinions on either candidate aside, the market views Clinton as a no-change to the current trajectory and Trump is an unknown in terms of what will change and what won't. I do believe there is some momentum into higher rates unless a Clinton headline interrupts the perceived advantage she has right now.
The chart below shows the 30yr APOR (average prime offered rate) versus the 10yr and 2yr. Note the little movement in mortgage rates recently despite the increase in treasury rates.