US Treasuries are poised to suffer this week.
Last week, the debt ceiling was extended until December, removing critical support for long-term Treasuries.
The debt-ceiling provided critical support for long term US Treasuries as they were providing safety amid a spike of volatility in money markets. Now that the US isn't running any longer into an imminent risk of default, the flight to safety, which was capping long term yields, has been removed. It means that US yields are free to rise amid this week CPI readings and long term bond auctions.
The nonfarm payrolls report on Friday did little to deter bond bears. Although the economy added just 194,000 jobs, the lowest since the beginning of the year, 10-year yields rose to break their resistance at 1.60%, showing that investors are focusing more on inflation rather than jobs. Indeed, unemployment fell more than expected to 4.8%. At the same time, the monthly average hourly earnings remain elevated, hinting at lasting inflation ahead.
That’s why the consumer price inflation data coming out on Wednesday are crucial for the bond market. Economists expect the CPI for September to match the one of August, showing a monthly increase of 0.3%, leaving the annual inflation gain at 5.3%. Any surprises on the upside could provoke yields to continue their rise towards 1.70%. According to a Bloomberg report, with 10-year yields above 1.60%, the bond market runs into the risk of convexity hedging. Convexity hedging happens when Mortgage-Backed Security (MBS) holders need to sell long-term bonds to decrease the duration of their overall portfolio. If that were the case, 10-year yields could quickly rise to test their yearly high at 1.77%.
Always on Wednesday, the US Treasury will sell 30-year bonds, and the FOMC Minutes will be released. They have the potential to apply even more pressure on the long part of the yield curve. Investors will be addressing the FOMC Minutes carefully, trying to understand what Jerome Powell meant last month when he said he'd need to see a "decent” jobs report to taper in November. We believe that despite the weak nonfarm payrolls, there are clear signs of recovery in the labor market. However, inflation is becoming a more pressing issue, forcing the central bank’s to finally taper.
Producer price inflation on Thursday and retail sales on Friday will also be important. Retail sales are expected to have decreased due to a plunge in vehicle sales caused by supply-chain disruptions. That's why it will be essential to look at these numbers in detail: as vehicle sales drop, other retail sales might rise.