As rates made their way lower in the month of May, our ongoing thesis was that gains would be limited by the fact that a true rally required many months of decent inflation data (something that would obviously take–well…–many months to play out). Our call was for the rally to end and for rates to enter a “volatile, sideways range.” The rally had ended even before this most recent surge toward higher rates. Now we’re hoping that the recent highs mark the ceiling of that volatile sideways range. At the very least, that is the decision that the bond market is wrestling with.
Long-term ceiling calls can’t really be made on days when 10yr yields hit that ceiling (i.e. overnight yields hit 3.495, and Tuesday’s high was 3.498). But even if rates do manage to rise a bit, it’s still the inflation data that determines the Fed policy stance which, in turn, determines the trend. In fact, the more we zoom out and consider bigger pictures, the more obvious it becomes that 2022 has quite simply been the year of Fed tightening. The more reason they’ve had to signal tightening, the worse things have gotten for stocks and bonds.
This is something that plays out over the shortest time horizons in the form of higher bond yields and lower stock prices in that classic mirror image pattern.
The mirror isn’t quite as perfect over longer time horizons because both sides of the market have their own cares and worries. But if we use inflation-adjusted Treasury yields, we can factor out one key worry for bonds, thus better isolating the Fed’s bond-buying impact.
NOTE: the dip back toward lower yields in early 2022 was due to the start of the Ukraine war.
The question implied by the chart above is “how long can the market continue increasing its expectations for Fed tightening?” This week saw a big jump after the CPI data. Ideally, that’s a quick adjustment and now we wait for the next big input. This morning’s big input was a surprise rate hike from the Swiss National Bank (SNB) that send EU bonds into a tailspin. US yields are pushing back nicely against that overnight weakness so far, but still moderately weaker on the day.