Markets are always forward looking. They will discount future information and include it in today's price. The US bond market is starting to move beyond the recession and liquidity story to now account for the deficit and inflation story. In the Fall, the bond market was fixated on a flight to quality but now the we are seeing a meaningful reversal in some Treasury relationships to account for the trillion plus deficit and the potential that longer-term debt will be monetized.
New home sales and durable good orders fall off a cliff and the bond markets take a dive on a poor five-year action. Forget about the bad economy, it is the financing and inflation stories that is driving the market right now.
Nominal rates have stopped declining and are increasing since the beginning of the year. The yield on 2-years have increased 25 bps form the lows in mid-December. Five years are up 45 bps, 10-years up 68 bps, and 30-years up 91-bps. There is a clear reaction that as you move out the yield curve there is more emphasis on funding and inflation.
Now there is a strong literature on the fact that deficits do not matter, but that was for deficit levels much lower than current projections. The market was stable until the bad 5-year auction. The Treasury sold $78 billion in a week. The market is suffering from supply exhaustion. If the market will not buy the bonds, then the Fed will have to monetize which has the potential for longer-term inflation.
Long-rates are mostly driven by inflation expectations which are all the more telling for the longer-term trends. Break-even inflation rates are all on the rise. For example, the 30-year break-evens are up almost 100 bps since the end of November. Even the short rate break-evens for say 2-years are showing a significant change. Here, the break-even has gone from negative 6.95 to -2.79. This is is a 400 bps change in about 45 days. The Fed has made an impression that they plan to reflate the economy and produce rising prices. Five-year numbers have moved from negative to positive territory although the change has not been as great.
New home sales and durable good orders fall off a cliff and the bond markets take a dive on a poor five-year action. Forget about the bad economy, it is the financing and inflation stories that is driving the market right now.
Nominal rates have stopped declining and are increasing since the beginning of the year. The yield on 2-years have increased 25 bps form the lows in mid-December. Five years are up 45 bps, 10-years up 68 bps, and 30-years up 91-bps. There is a clear reaction that as you move out the yield curve there is more emphasis on funding and inflation.
Now there is a strong literature on the fact that deficits do not matter, but that was for deficit levels much lower than current projections. The market was stable until the bad 5-year auction. The Treasury sold $78 billion in a week. The market is suffering from supply exhaustion. If the market will not buy the bonds, then the Fed will have to monetize which has the potential for longer-term inflation.
Long-rates are mostly driven by inflation expectations which are all the more telling for the longer-term trends. Break-even inflation rates are all on the rise. For example, the 30-year break-evens are up almost 100 bps since the end of November. Even the short rate break-evens for say 2-years are showing a significant change. Here, the break-even has gone from negative 6.95 to -2.79. This is is a 400 bps change in about 45 days. The Fed has made an impression that they plan to reflate the economy and produce rising prices. Five-year numbers have moved from negative to positive territory although the change has not been as great.
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