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Treasury Yield Slump Stokes Recovery, Inflation Debate; 10-Year Hits 1.25%

Benchmark 10-year note yields have fallen more than 30 basis points since the Federal Reserve's 'hawkish" policy statement on June 16.

U.S. Treasury bond yields extended declines Thursday, pulling 10-year notes to a fresh five-month low, as investors work to unpack growth and inflation signals from the world's biggest financial market. 

Bets on a post-pandemic surge in consumer demand, fueled by trillions in government stimulus, record-low borrowing costs and early successes in vaccine rollouts, has given way to growth concerns linked to a surge in Delta-variant infections, labor and raw materials shortages and a pullback in retail spending.

ISM data published Tuesday indicated a notable slowdown in services sector activity -- a key driver of U.S. economic growth -- while the Atlanta Fed's GDPNow forecasting tool is indicating a third quarter advance of around 7.8%, down from 8.6% at the start of the month.

This week's 7% 'top-to-bottom' slide in oil prices, predicated on both the surge in Delta-variant cases in Asia and the chaos linked to the collapse of OPEC discussions on output curbs, also accelerated the Treasury market rally.

That weakness was expressed in minutes of the Federal Reserve's last policy meeting, which ended in June 16, which showed officials remained concerned about 'downside risks' to the recovery and insisted that benchmarks of "substantial further progress" on jobs and inflation haven't been reached. The assessment likely means the Fed is unlikely to alter the pace of its $120 billion in monthly bond purchases until much later in the year.

"In discussing the uncertainty and risks associated with the economic outlook, participants commented that the process of reopening the economy was unprecedented and likely to be uneven across sectors," the minutes read. "Some participants judged that supply chain disruptions and labor shortages complicated the task of assessing progress toward the Committee's goals and that the speed at which these factors would dissipate was uncertain."

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Benchmark 10-year Treasury note yields were last seen 4.5 basis points lower in the overnight session at 1.278% after hitting 1.25% earlier in the session, the lowest since mid-February, a move that marks a 33.1 basis point decline since the Federal Reserve's 'hawkish' policy statement on June 16.

Hints from lawmakers in China yesterday to near-term interest rate cuts added to the concern, as it suggested the world's second largest economy may suffer from both domestic demand pressures and the slowdown in trade that's likely to follow the current wave of Delta-variant coronavirus infections seen around the world. 

Curiously, even as concern for a slowdown in Asia -- and elsewhere -- gains traction, inflationary pressures remain, with China reporting the biggest surge in factory gate prices since 2008 last month and the most recent JOLTs job openings data showing a record high 9.2 million vacant positions in the U.S. labor market, suggesting employers will need to boost wages even beyond last month's 3.6% increase to entice people back onto the shop floor.

The Fed's preferred measure of U.S. inflation, the core PCE Price Index, surged the most in nearly three decades for a second consecutive month in May a reading matches the signals from the Commerce Department's May retail sales tally, which showed a 1.3% decline to $620.2 billion as the impact of stimulus from the American Rescue Act continued to fade and CPI rose at the fastest pace in more than ten years.

Still, ING rate strategist Padhraic Garvey thinks 10-year note yields are "more attracted to 1% than 2%" even at these reduced levels, although "material taper talk could spark a change".

"The US is key here, and simplistically there are two outcomes ahead. One is a 1-handle outcome. This is where the 10-year grinds down towards 1% (extrapolate the path we are currently on)," Garvey said in a client note Thursday. "The other is a 2-handle outcome, where the US 10 year reverts higher and ends up at 2-point-something." 

"That’s our macro-inspired central view, but it’s proving to be a heavy lift," he added. "Proper taper talk should be determinative, and if that does not push us there, then it’s hard to know what will."