8 July 2021
Past the peak?
With the US 10-Year Treasury yield breaking lower over the past week, we examine the drivers of this move and our outlook for rates.
The upward momentum of the post-pandemic recovery has paused, with recent economic data prints suggesting that we are past the peak of acceleration. For example, last week’s business surveys recorded their first material setback since the re-opening, with the US ISM services index and the global services purchasing managers’ index (PMI) both coming in weaker than expected (the former actually declined month-over-month). There also exist tentative signals that manufacturing supply bottlenecks are peaking, as ISM backlogs begin to fall. That said, overall levels of economic activity remain robust, both in the US (as evidenced by the June US employment print of 850k non-farm payrolls – the strongest pace of jobs growth since August) and in Europe, where PMIs continue to reach new highs. While indicators may remain choppy as we witness temporary setbacks caused by the Delta variant, overall pandemic headwinds are fading and service sector activity is normalising. This backdrop should see the Federal Reserve (the Fed) maintain its current narrative of an initial paring back of policy in the first quarter of 2022, and we did not witness a material change in guidance from the June Federal Open Market Committee minutes.
Amid the new economic data prints, the US 10-Year Treasury yield broke through some key technical levels over the past week, having fallen from 1.46% on 1 July to 1.31% on 7 July. Since the beginning of the year, yields have re-traced approximately half of the widening from the peak of 1.74% witnessed on 31 March. While these recent moves seem incongruous with the strong growth backdrop, the market appears to be reacting to concerns around the “peak” in data acceleration, as well as risks posed by the Delta variant. However, as growth stabilises and the economy continues to recover in line with the Fed’s expectations of “substantial progress”, we expect a reversal of this trend as investor attention shifts to the anticipated taper trajectory announcements in the late summer. With no obvious immediate catalyst to move rates drastically, we believe the path of least resistance is a slow drift higher over the medium term.
10-Year US Treasury yields appear to be reacting to concerns around the “peak” in data acceleration
The technical backdrop is benign for bonds. On the one hand, weekly demand for bonds (both retail and bank holdings) is surpassing longer-term averages. We expect the substantial amount of liquidity in the system to continue to act as a backstop to an imminent jump in yields. While investors have become less short on rates than in previous weeks, market consensus is still short, which will continue to act as a headwind to higher yields, and should also increasingly play out with more audible taper talk in the third quarter of this year.
What does this mean for fixed income investors?
While we may have passed the peak in fundamental data acceleration, all-in growth and economic activity levels remain strong. This backdrop paves the way for the beginnings of central bank normalisation, and for yields to drift higher over the medium-term at a more deliberate pace than the sharp moves over the past quarter. Investors should be mindful to monitor consensus short positioning in tandem with economic data prints as we move further into the post-pandemic era.
About the Bond Bulletin
Each week J.P. Morgan Asset Management's Global Fixed Income, Currency and Commodities group reviews key issues for bond investors through the lens of its common Fundamental, Quantitative Valuation and Technical (FQT) research framework.
Our common research language based on Fundamental, Quantitative Valuation and Technical analysis provides a framework for comparing research across fixed income sectors and allows for the global integration of investment ideas.
Fundamental factors include macroeconomic data (such as growth and inflation) as well as corporate health figures (such as default rates, earnings and leverage metrics)
Quantitative valuations is a measure of the extent to which a sector or security is rich or cheap (on both an absolute basis as well as versus history and relative to other sectors)
Technical factors are primarily supply and demand dynamics (issuance and flows), as well as investor positioning and momentum