Wednesday's twenty-year US Treasury auction is in focus as it could spark volatility in the long part of the yield curve.
Interest rate hike expectations continue to be a focus as investors keep their eyes on inflation and economic growth. Although central banks on both sides of the Atlantic appear comfortable sticking to their average inflation-targeting frameworks, investors cannot ignore inflation soaring. The US core CPI hit a 30-year high in October. The spike in energy prices has now leaked to fertilizers, thus food. Households, which are now preparing for Thanksgiving and Christmas, cannot help but look horrified as inflation rates outpace wage growth. Hence, the reason why the Michigan consumer sentiment dropped to a 10-year low this month.
Inflation is now driven by supply-chain disruptions exacerbated by continuous accommodative monetary policies. Hence, investors expect central banks to respond with interest rate hikes to avoid the economy from overheating. As rate hikes expectations advance, yield curves bear flatten as a response.
However, something begins to worry credit markets: it’s becoming clear that an environment with elevated inflation and low interest rates is not sustainable. Many have highlighted that long-term rates remain stable because higher interest rates in the short term might be detrimental to growth in the medium to long term. According to that logic, the yield curve would flatten or even invert as the front part of the yield curve will continue to soar, but long-term yields would barely budge on the prospect that stimulus will shortly be needed for the economy to recover. This idea led many to conclude that the marry goes round continues. If 10-year yields, which are a benchmark for mortgage rates and credit spreads, remain stable, that means that long term borrowings will continue to be cheap.
Yet, last week’s 10-year and 30-year US Treasury auctions sent a troubling message: investors need higher yields across the whole yield curve as inflation keeps rising. A few days after seeing 10-year US yields dropping more than 15bps to 1.41%, yields rose back to 1.56% amid weak demand during the US Treasury auctions. The 20-year tenor is far less popular, suggesting that demand could be even lower than what we saw last week, with the potential to send shockwaves in the long part of the yield curve.
Tomorrow's retail sales will also be in the spotlight; however, they might play a minor role in moving yields.