By Serafino Tobia, Managing Director & Head of Agency CMBS Trading, Greystone
10-year Treasuries are at 4.18% as of March 1, 2024, 30 basis points (bps) higher since the beginning of February (3.88% as of 2/1/24). 2-year Treasuries are at 4.52%; 32 bps higher since February 1st. The higher yields this past month were fueled by a series of higher-than-expected January inflation prints (announced in February) that put to rest any notion that that the Fed was about to start accommodating lower rates - early and often. January’s core inflation prints (without the more volatile food and energy prices) were 0.4% month-over-month – that’s a pace of 4.8% annualized. There is a strong argument that January’s inflation numbers are a turn-of-the-year anomaly; no one really expects this pace of price increases to be sustained. The bond market will now focus on the employment report (March 8th) and February’s inflation data (CPI, March 12th and PPI, March 14th) followed by the FOMC meeting and rate decision (and new Dot Plot) on March 20th. In the meantime, traders and investors will be listening to the Fed officials for clues of their timeline for rate cuts and continue to evaluate data related to the health of the economy. 10-year Treasuries are likely in a new range of around 4.25% +/- 15 bps as the market looks for further clarity on inflation.
Stepping back a bit for a longer perspective, starting in the third week in October with the high mark on 10-year Treasuries at 5.02% (10/23/2023), the bond market rallied strongly into December and remained in a trading range around 4% +/- 0.15% up until the beginning of February. An about-face change in sentiment started after Bill Ackman (CEO of Pershing Square hedge fund) posted on “X” about covering his short positions in long-dated US Treasury bonds. Bullish sentiment was spurred further by the Fed moving from (Y) a bias to raise Fed funds rates another quarter point to (Z) a view that the Fed funds rate is restrictive with a bias towards lower rates in 2024. Additionally, prior to the most recent inflation prints for January (announced in February), we received a series of CPI, PPI and PCE inflation numbers that reflected lower price inflation suggesting a glide path lower towards sub-2% inflation (like we had pre-pandemic). The November PCE index (announced 12/22/23) was actually negative -0.1% on a month-over-month basis, and 2.6% year-over-year. 10-year rates moved down to 3.80% at the end of 2023 (12/27/2023). Paul Krugman, economic opinion columnist for The New York Times, named this “Immaculate Disinflation” (i.e., lower inflation without a recession).
During December and January, the bond market was front-running rate cuts by the Fed. The yield curve and Fed funds futures on the Chicago Mercantile Exchange implied that the Federal Reserve would start lowering the Fed funds rate as early as March and that the Fed funds rate would be as much as 1.70% lower by year-end 2024. I say “front-running” because, at that time, Fed Chairman Powell and other Fed officials were saying that a cut in the Fed funds rate in March is unlikely and the Fed’s own Dot Plot forecast (from the December FOMC meeting) indicated just a 0.75% reduction in the Fed funds rate by year end 2024.
10-year Treasuries traded in around 4% +/- 15 basis points during January looking for signs that the economy would start to soften and for further confirmation that inflation would continue to improve. Instead, we received a blockbuster US Employment Report on 2/2 - January nonfarm payroll gained +353,000 new jobs (vs +185,000 consensus estimate). Also, December’s job growth was revised higher by +117k (+333k new jobs as revised). In other words, two months in a row of 300k+ job growth. Overall, a great jobs report for the economy (but not so good for lower interest rates). 10-year Treasuries moved higher by 15 basis points after the employment report by the close of business on 2/2.
To further the bearish shift in sentiment, the January inflation prints (announced in February), reflected an uptick in the rate of inflation. To gauge the most current trajectory of inflation, bond market participants, economists and the Fed focus mostly on the month-to-month change in “core” inflation without the more volatile food and energy prices. For January, month-over-month:
• Core CPI (announced 2/13), showed consumer prices higher by +0.4% (vs. December’s print at +0.3%).
• Core PPI (announced 2/16), showed producer prices higher by +0.5% (vs. December’s print at neg. -0.1% as revised)
• Core PCE (announced 2/29), printed higher by +0.4% (vs. +0.2% the previous month)
Treasury investors backed off their overly optimistic expectations; interest rates moved higher throughout February. The bond market has come to the Fed’s view of just a 0.75% drop in the Fed funds rate by year-end 2024. The current Fed funds rate is at the 5.25%-5.50% target range, arguably restrictive. No change in the Fed funds rate is expected at the next Fed FOMC meeting (March 20); the Fed will also likely skip a move at the following FOMC meeting (May 1) and will look to start to lower the Fed funds rate by 0.25% at the subsequent meeting (June 12). Before the Fed starts moving the Fed funds rate lower, the Fed will want to see a few more prints of inflation data that are consistent with inflation moving towards the Fed’s 2% inflation target. We obviously didn’t get that with the January inflation prints.
As we know first-hand, higher interest rates have had a direct impact on commercial real estate. However, a good part of the economy has remained strong – sub-4% unemployment rate, healthy growth in US production – 2023 Q3 GDP +4.9%, Q4 GDP +3.3%. Economists point out that most homeowners and companies refinanced during the near-zero rate period a few years ago and therefore a good chunk of the economy is insulated from the restrictive interest rates.
After the March 20th FOMC meeting, the Fed will release a new Dot Plot (a survey of the 19 U.S. Fed officials) revising where they anticipate the Fed funds rate to be by year end 2024 and year end 2025. Traders and investors are debating if the uptick with inflation in January is an anomaly or evidence that inflation will remain sticky at 3% or move higher. It’s worth noting that some economists have pointed out that January inflation data can be somewhat misleading – with the turn-of-the-year, businesses often reflect a one-time price increase and January’s inflation rate is not likely to be sustained going forward. If February CPI and PPI inflation prints come in hot like January, we may well see a slower Fed Dot Plot forecast path for Fed funds rate cuts both for this year and for 2025. Treasuries along the entire yield curve would likely reflect the slower pace of rate cuts and a marginally higher yield environment.