Macro: It’s all about elections and keeping status quo
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
Head of Fixed Income Strategy
Summary: Ten-year US Treasuries yields may rise fast towards 1.5% once they break above their upper trendline at 1.22%. When we compare 10-year Treasury yields to the 10-year Breakeven rate, we find that there is a mismatch between the two. Either inflation expectations are too high, or 10-year yields lag the breakeven by 100 basis points, giving more context to a substantial selloff. On the other hand, 30-year Treasury yields are not as far away from inflation expectations, but there is potential for them to rise to 2.4% in yield.
Last week 10- and 30-year yields hit a new high since February 2020. The fear for inflation to surprise on the upside is a concern that started to push US Treasury yields higher since Biden won the November election. However, which yield levels should we watch out for?
Starting from the 10-year yields, we see that they have been trading in a downtrend channel for decades. Interestingly, a horizontal line around 1.5% has served as support since 2012. That horizontal line was broken in February last year amid the Covid-19 pandemic. Now it serves as a resistance level if yields break and sustain trading above 1.22%.
As we take a closer look, we see that although 10-year yields closed last week at 1.2%, they failed to break above their horizontal resistance line at 1.22%. We are now facing two scenarios: either yields break and sustain trading above 1.22%, or they will fall to try the lower trendline of the channel they have been trading since August 2020. Suppose 10-year yields break above the 1.22% resistance line. In that case, yields might rise fast towards 1.5%. Yet, as highlighted above, the 1.5% level is a strong resistance level, giving the market some respite after the selloff in Treasuries. A strong auction of TIPS this Thursday and retail sales numbers can be catalysts for such selloff. Additionally, if yields sustain trading above 1.22% a catch-up effect can trigger bond future stops causing a fast rise to 1.5% in yield.
When comparing 10-year yields to the 10-year Breakeven rate, it looks that the selloff in Treasuries can be even more significant than what we discussed above. Indeed, the difference between the 10-year Breakeven rate and 10-year Treasury yields is around 100 basis points -the highest in twenty years. It means that either inflation expectations are too high, or 10-year Treasury yields are too low and will need to rise by 100bp to catch up with it.
Although 30-year yields are also trading below the 30-year breakeven rate, it is essential to note that the spread between the two of them is only of 15bps. It means that 10-year Treasuries are significantly more overpriced compared to their 30-year peers.
As per the image below, thirty-year Treasuries have also hit a milestone last week, hitting 2% in yield for the first time in a year. If they sustain above this level and break above the channel, they have been trading in since August they will find support next around 2.4%. Otherwise, they would fall to test resistance on their lower horizontal line at 1.75%.