By Serafino Tobia, Director of Agency CMBS Trading and Portfolio, Greystone
The 10-year Treasury traded in a 22-basis point range this past week (4.38% - 4.60%) and is currently at 4.49% as of this morning – right in the middle. Rates drifted to the high end of the range on Monday and Tuesday (recall, it was just a week ago that we were all focused on 25% tariffs with Canada and Mexico.) Yields improved on Wednesday, probably due to bond-friendly comments from Treasury Secretary Scott Bessent. Yields moved back to 4.50% Friday morning with the US employment report reflecting a stable/strong labor market and wage growth that likely keeps the Fed on hold with further rate cuts. Over the weekend, President Trump commented that we would be adding a 25% tariff on aluminum and steel imports – but bond investors haven’t reacted yet (probably waiting to see if this is just a negotiating position).
On Wednesday last week, in an interview with Larry Kudlow of Fox Business, Treasury Secretary Scott Bessent commented that the Trump Administration’s interest rate strategy is focused on the 10-year Treasury yield and not so much on the overnight Fed Funds rate. Bessent commented that if the Administration is able to reduce regulations, get energy prices down, and pass the tax bill along with a more austere fiscal spending budget, 10-year rates should come down. Bessent repeated his economic policy mantra of 3-3-3 — referring to getting the fiscal deficit down to 3% of GDP (versus over 6% in recent years), boosting oil production by 3 million barrels a day, and sustaining economic growth at 3%. Bessent also indicated his intent to maintain the current volume of longer-term bond sales, despite previously indicating that he favors adding supply on the long-end by terming-out short-term Treasury bills that the US Treasury largely depends on for funding the country’s debt.
Last Week’s Economic Data
The data last week continued to reflect a healthy labor market. The “main event” was Friday’s jobs report printing the unemployment rate at 4% (versus 4.1% last month) and an outsized increase in wages.
- JOLTS Job Openings Report – On Tuesday, the December JOLTS printed at 7.6 million, reflecting a slightly weakening job market. Job openings were down from last month, but recognize that the level is still about the pre-pandemic 2019 average of 7.15 million; job openings were over 12 million during the pandemic. The higher number indicates stronger demand for labor.
- ADP Jobs Report – On Wednesday, according to ADP, employment gained 183,000 new jobs in December versus 150k expected. November’s print was revised higher to 176k versus 122k previously reported.
- ISM Services Index – Also on Wednesday, the ISM Services Index printed at 52.8 for January, lower than the 54-level forecasted. Hard to say if this is an early sign of weakness in the services sector (or a low print that’s just a normal variation).
- US Employment Report – On Friday, The January non-farm payroll grew by +143,000 new jobs, marginally lower than Wall Street’s estimate at +175k but December’s print was revised higher to +307k new job versus 256k). The unemployment rate moved lower to 4.0%, versus last month at 4.1%. Average Hourly Wages (also part of the labor report), moved higher by 0.5% for the month versus 0.3% expected and last month’s print.
- University of Michigan Consumer Sentiment Index – Also on Friday, the U-Mich sentiment index printed at 67.8 (-4%), sharply lower than the 71.8 estimate. The U-Mich survey also indicated that consumers expect inflation of 4.3% over the next 12 months (versus 3.3% print last month) – not sure what to make of this significantly higher inflation estimate other than consumers are concerned about inflation reigniting.
Fed Monetary Policy – On Hold
As you know, the Fed’s FOMC met a week and a half ago and left the Federal Funds rate unchanged at 4.33% (4.25% to 4.50% target range). With a backdrop of a strong labor market and uncertainty about the new Administration’s fiscal policies (tax cuts, deficit spending) and tariffs, the Fed has no reason to move quickly with further rate cuts. On Thursday last week, Dallas Fed President Lorie Logan expressed the view that the current Fed policy is about right, close to neutral, and that further rate cuts are unwarranted any time soon. Fed Chairman Powell and most of the FOMC committee still view a 4.25%-4.50% Fed Funds rate as restrictive, but we are just going to have to wait to see how the economy evolves. The Fed meets next in March, (3/19), May (5/7) and then in June (6/18). According to what is implied by the yield curve/futures, the Fed will stay on hold at the next two FOMC meetings in March and May. The yield curve implies that there is a 69% chance of a 0.25% rate cut at the June meeting.
My Take on Longer Term Yields
A 4.50% (+/- 15 basis point range) rate for the 10-year Treasury yield still makes sense to me. Despite Friday’s U-Mich consumer survey one year inflation expectations printing at 4.3%, most evidence is that inflation is sticky at around 2.50% (as measured by the PCE index). We will see how the CPI and PPI inflation indices come in this week. Fundamentally, 10-year yields are a function of expected inflation plus a spread for a real yield and for term risk. Obviously, it’s not that straightforward; the spread is influenced by investor sentiment (front-running in one direction or the other) as well as the supply and demand of Treasury securities.
Undeniably, bond investor sentiment is cautious, fueled by the Fed’s slower pace to normalize rates, a healthy jobs market, sticky inflation and concern over the Trump Administration’s tariff plans and fiscal policy. It has been only a week since the focus was on the tariffs (and retaliatory tariffs), and we are in the midst of a one-month delay since Mexico and Canada agreed to address border security and the illegal flow of fentanyl. Meanwhile, the 10% tariffs on China imports, 25% tariffs on aluminum and steel imports and possible tariffs on imports from the European countries are likely proceeding. As Trump’s tax cut plans take shape over the next few weeks and months, the bond market will want to see “pay-for” offsets to reduce the impact of the tax cuts on the deficit and debt. We could see yields move higher if investors get concerned about inflation (reigniting with tax cuts, deficit spending and additional supply of Treasuries). On the other hand, over the next few months, we may start to see employment weaken or bond-friendly inflation prints (i.e., inflation resuming a trend towards 2%), and investor sentiment could move 10-year yields back towards 4%.
Upcoming Economic Calendar
The highlight of the economic data this week will be the January consumer price index (CPI) on Wednesday and producer price index (PPI) on Thursday. The key data point will be Core CPI (without the more volatile food and energy prices); the market is expecting +0.3% for the month (versus 0.2% in December). Headline CPI is forecasted at +0.3% month-over-month (versus 0.4% last month). This week, we will also see Retail Sales figures on Friday. Finally, on Tuesday and Wednesday, Fed Chairman Powell delivers semi-annual monetary policy testimony to Congress.
The information provided in this email, 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.