Quarterly Outlook
Equity outlook: The high cost of global fragmentation for US portfolios
Charu Chanana
Chief Investment Strategist
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Today’s CPI numbers are pivotal for the bond market
Althea Spinozzi
Head of Fixed Income Strategy
Summary: The 5s30s spread has formed a triple bottom reversal pattern telling us we might be approaching a turning point with today's US CPI numbers. If the monthly core CPI numbers surprise on the downside, falling to 0.2%, it will give reasons to bond futures to remove Fed hike bets for this month and the rest of the year, igniting a buying spree that would see the yield curve steepening with the belly of the yield curve outperforming. The same il likely to happen if the CPI data meets expectations. However, if the numbers surprise on the upside, the 5s30s spread might break below its support with a big move, implying more aggressive Fed policies. Within this context, the forward real Fed fund rate can be used as a compass to understand the Fed's next moves.
US yields have retreated from their highs. However, today's CPI numbers might reignite the selloff. Core CPI is expected to decrease from 0.4% MoM to 0.3%, and the yearly figure to 5% from 5.3%. A surprise on the upside might push the market to price an aggressive Federal Reserve, forcing bond futures to envision a second rate hike, as shown by the dot plot.
However, lower-than-expected inflation, particularly a monthly core CPI of 0.2%, might lead the market the other way, believing that the Fed might not need to tighten the economy any longer, decreasing the chances of another rate hike.
In this piece, we are going to look at US Treasury yields to understand what is going to be their likely move.
The yield curve is telling us we are at a pivotal point
The spread between 30- and 5-year yields formed a triple bottom and reversal pattern. Technical analysis tells us that the yield curve is likely to steepen, with long-term yields rising or dropping faster than the belly of the curve. This move is likely if CPI numbers meet expectations or surprise on the downside, showing that we might be at the end of the tightening cycle.
However, if the 5s30s spread breaks below resistance at -46bps, the move can be significant, flatting further the yield curve. That could happen if today's CPI numbers surprise on the upside showing that the Fed might need to tighten the economy further, risking a recession.
2- and 10-year yields are in a correction
Two- and ten-year yields have fallen from their highs. If the CPI numbers meet expectations, they will likely continue to correct. However, they might bounce back later, depending on the FOMC meeting and the PCE deflator numbers at the end of the month.
The Real Fed fund rate indicates when the Fed might stop
A good way to understand when the Federal Reserve is going to be done with hiking interest rates is to look at the real Fed Fund rate, which now is indicating that on a forward basis, the central bank is looking to bring the Fed fund rate at 2%, three times higher than where it is trading today. However, how can it get there? There are two ways:
- Core inflation is going to fall faster than expected.
- The Fed needs to hike rates additionally if inflation doesn’t budge.
Although the pattern is uncertain, real Fed fund rate expectations give us a compass to understand the Fed's next steps.
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