By Serafino Tobia, Managing Director & Head of Agency CMBS Trading, Greystone
10-year Treasury yields are at 4.35%, moving to the low end of the recent range after a bond-friendly April PCE inflation print on Friday (5/31) followed by a weaker than expected ISM Manufacturing Index print on Monday (6/3). Early last week, yields moved higher with tepid demand for the bonds auctioned by the US Treasury; as of the close on Wednesday (5/29), the 10-year Treasury stood at 4.61%. Bond investors, however, are refocused now on both the marginally better inflation numbers and marginally weaker economic data foreshadowing easier monetary policy from the Fed and a Fed Funds rate cut.
The PCE inflation numbers were incrementally better/lower (and largely in line with Wall Street estimates). The year-over-year headline PCE index printed +2.7%, annual Core PCE (without the more volatile food and energy prices) printed at +2.8%. For the month of April, the headline PCE index printed at +0.3%, as expected and the same as the previous two months. The Core PCE index month-over-month was +0.2% (actually, +0.249% unrounded). Clearly a step in the right direction especially after the higher prints during the first 3 months of the year (monthly Core PCE for January +0.5%, February +0.3% and March +0.3%). However, annualized, Core PCE Index is 3% (0.249% x 12); and that doesn’t get us to Fed rate cuts without further improvement. The May ISM Manufacturing Index composite came in at 48.7, down ½ point from April’s number. Wall Street was expecting a slight uptick to 49.6. A print below 50 represents contraction in the economy.
Since July 2023, the Federal Reserve Bank has maintained a restrictive overnight Fed Funds rate; 5.25%-5.50% range. There are two paths to Fed Funds rate cuts – (1) an improvement in inflation that gives the Fed confidence that we are back on track towards the Fed’s 2% inflation target or (2) a weakening economy that necessitates the Fed to address their full employment objective with an easier money policy. For the Fed to start cutting rates, we probably need inflation prints at +0.2% month-over-month for two months in a row (or an unemployment rate higher; 4.1% or 4.2% unemployment rate, versus 3.9% currently).
I wouldn’t be waiting for any major improvement in interest rates; we’ve been in a range of between 4.35% - 4.70% for the past 60 days and now at the low end of this range. If you believe (as I do) that the economy is moving towards a soft landing (not a significant recession) and that inflation will stay sticky at around 3% annualized we won’t likely break out much lower. Also, on a fundamental basis, even if we get further improvement on inflation to around 2.5% and the Fed starts to normalize rates, the 10-year should be around 4.25% +/- (i.e., inflation goes to ~2.50%, implying a ~3.50% overnight Fed Funds rate and an add-on spread for term). Despite my thinking about fundamentals, there may well be momentum that carries 10-year Treasury yields down to 4% or lower. We saw that just six months ago when the market was pricing-in 150+ basis points in Fed Funds rate cuts and the 10-year Treasury traded as low as 3.80% (12/27/2023). The bond market wasn’t totally irrational; we had Core PCE inflation prints of about +0.1% in each of the last three months of 2023, only to be disappointed by a print at +0.5% for January 2024.
This week’s economic data includes a series of employment figures, highlighted with the US Employment Report (non-farm payroll and unemployment rate) on Friday (6/7). The market consensus is for +190,000 new non-farm payroll jobs (versus last month’s job growth at +175,000) and for the unemployment rate to remain at 3.9%, the same as last month. The bond market will also focus on the Average Hourly Earnings print on Friday (6/7), a gauge of wage inflation; the consensus estimate is for an increase of +0.3% month-over-month (vs. last month’s +0.2% print). Additional economic data weighing in includes a JOLTS Job openings report on Tuesday (6/4) and an ADP Jobs report on Wednesday (6/5) and Weekly Initial Jobless Claims on Thursday (6/6).
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