By Serafino Tobia, Director of Agency CMBS Trading and Portfolio, Greystone
US Treasuries
The 10-year benchmark Treasury yield is at 4.44% as of this morning, four basis points lower since last Tuesday. 10-year bonds traded in a 15-basis point range this past week (4.39% - 4.54%). On Wednesday, a federal trade court ruled that the Liberation Day reciprocal tariffs were illegal, prompting a stock market rally and pushing bond yields to the high end of the range. On Thursday, yields dropped 8-10 basis points across the entire yield curve after the 8:30 AM data showed signs of an economic slowdown – slower consumer spending, higher than expected continuing jobless claims, and the GDP report (2nd read) confirming a slightly negative print. Yields were also helped on Thursday by a federal appeals court pausing Wednesday’s ruling against tariffs and a successful auction of $44 billion 7-year Treasury notes.
Last Week’s Economic Data
- Conference Board Consumer Confidence Index – Consumer confidence Index for May printed sharply higher at 98 versus 85.7 last month. But not so fast...the survey was taken the week after the May 12th reset of the China tariffs.
- GDP 1st Quarter – The 2nd read of Q1 GDP printed at -0.2% annualized pace, slightly better than the first read a month ago (-0.3%). However, as previously noted, GDP is calculated by subtracting imports and imports were high in the first quarter as businesses pulled forward imports to avoid tariffs. When you normalize imports, production is over +2% and relatively healthy.
- Jobless Claims – Initial jobless claims came in on the high side this week at 240,000 (versus last week at 226k). However, the bigger news for the bond market was the increase in continuing claims, the number of people receiving benefits after an initial week. Continuing claims printed at 1.919 million, +26,000, the highest level since November 2021 (during the pandemic). Elevated continuing claims reflect companies' hesitance to increase headcount because of economic uncertainty. Weekly jobless claims are closely watched as an early indicator of the state of the labor market.
- Personal Income and Personal Spending (April) – Personal Income for April was higher by +0.8% versus 0.3% expected; Personal Spending printed +0.2% (versus 0.7% in March).
- Pending Home Sales – Lower by 6.3% in April.
- PCE Inflation Index – The headline PCE index for the year printed at 2.1% in April versus 2.3% last month (and only 0.1% above the Fed’s target). Core PCE year-over-year, printed at 2.5% (versus 2.6% as of last month). For the month, both headline and core came in at a subdued +0.1%.
- University of Michigan Consumer Sentiment – May’s consumer sentiment printed at 52.2, an improvement versus last month (50.8). U Mich Consumer inflation expectations improved but are still elevated; consumers expect 6.6% inflation over the next year (versus 7.3% as of last month). 5–10-year inflation expectations improved to 4.2% versus 4.6% as of last month).
Fed Monetary Policy: Wait-and-See Extended
The overnight Fed Funds rate has been pegged at 4.33% (target range 4.25% - 4.50%) since December 2024; that’s after the Fed reduced rates by 1% during the 4th quarter of last year. The Fed is holding the line on further rate cuts pending how inflation and the economy responds to the administration’s tariff policies and fiscal policies (tax cuts and spending). Headline inflation continues to inch towards the Fed’s 2% inflation target, however core inflation (without the more volatile food and energy prices) remains sticky at 2.5% and inflation is expected to move higher with higher tariffs and additional deficit spending.
As you know, the Fed has a dual mandate – stable prices and full employment. The next rate cut likely comes from a slowdown in the economy and higher unemployment along with the Fed looking through any inflation uptick as a one-time temporary increase related to tariffs. This Friday’s US employment report will be highly watched by bond traders and investors to gauge when the Fed may look to resume rate cuts. The shape of the yield curve implies 0.55% in rate cuts by year-end—equivalent to a little more than two ¼ point rate cuts. The first ¼ point rate cut is anticipated at the FOMC meeting on September 17th or October 29th.
My Take on Longer Term Yields
Long-term yields are primarily a function of inflation expectations; by definition - inflation plus a spread for a positive rate of return and an additional spread for term risk. The input factors to inflation expectations and term risk premium include the strength of the economy, the level of government spending/deficits, Fed monetary policy, supply and demand for Treasury securities and market sentiment/uncertainty of future economic conditions.
10-year Treasuries at 4.50% +/- is about right if you figure inflation at 2.50% (Core PCE Index at 2.50% this past year). As previously noted, business and consumer surveys consistently point to a slowdown in the economy in response to the higher tariffs that are just now showing up in the data (after a pull-forward of imports and spending on anticipation of tariffs). The consensus is that the administration will likely proceed with higher trade tariffs; the trade court’s ruling on the legality of the Liberation Day tariffs and the appeals court’s temporary stay are seen as only a minor obstacle in the process. We are therefore likely to see slower growth and a weaker jobs market over the next few months and bond investors will front-run the Fed and move rates lower towards 4%.
There is another narrative that implies interest rates stay elevated or move higher. Inflation is expected to move higher with tariffs, even if just a one-time adjustment. Further, the budget bill working its way through Congress is expected to increase deficit spending by another $3-4 trillion over the next 10 years. Deficit spending is concerning for investors since the US government is already overspending to the tune of $2 trillion per year +/-, about 6% of GDP. Additionally, the roll-out of Trump’s tariff policies has undermined the confidence of the US dollar and Treasuries as safe-haven assets which has been reflected in weaker demand for Treasuries from foreign investors.
Heads or tails? I expect we will see the negative effects of the tariffs over the next few months, the economy weakens, and investors front-run to push interest rates towards 4%.
This Week’s Economic Data
This week’s economic data releases will include several reports on the labor market, including JOLTS job openings on Tuesday, ADP employment on Wednesday, jobless claims on Thursday and the US employment report on Friday.
The information provided in this article, including, without limitation, any opinions, predictions, forecasts, commentaries or suggestions, is for informational purposes only and should not be construed to be professional or personal investment, financial, legal, tax or other advice.