Painting a 3% to 4% range for the US 10yr

In recent weeks the US yield curve has shifted higher and the curve inversion has deepened further. The 10yr is now at 3.8%, and the 2yr is back above 4.8%, stretching the 2/10yr inversion back above 100bp. There is room for the 2yr to rise to 5% on the likelihood that the market prices out the rate cut bias just about discounted for the December 2023 meeting. Remember the 2yr was above 5% just before Silicon Valley Bank (SVB) went down.

The latest core PCE number at 4.9% reminds us that the US is still a '5% inflation economy'

The latest core PCE number at 4.9% reminds us that the US is still a '5% inflation economy'. We think this will change (inflation will ease lower), but for now it is what it is until dis-proven. The issue is that activity data is not lying down. The latest consumer confidence number for June, for example, has popped back out to 109.7 (versus 100 at neutral). Market rates can only rise given this, albeit muted by recent good demand for bonds. Had it not been for this recent buying we’d already be at 5% for the 2yr and 4% for the 10yr yield. But based on what we see in front of us, we are likely to get there.

The rising pressure on market rates is also underpinned by a Federal Reserve that continues to sound quite a hawkish tone on worries that the inflation monster remains alive and well. The Fed skipped the rate hike opportunity for June, but seem very ready to resume hiking at the July meeting. There is over an 80% probability attached to a 25bp hike from that meeting. Beyond that, there is a 50:50 chance attached to the delivery of one final 25bp hike.

We target the 10yr Treasury yield to get back up to the 4% area for a while

The rationale for maintenance of rate hikes for now is centred on the stickiness of inflation and the refusal of the economy to slow by enough to really quell inflation pressures. We actually think the Fed has done enough and could simply hold here rather than hike. But the Fed has made it pretty clear that it thinks it needs to keep hiking some more. The Fed will want to do the rate hiking exercise once, and not to have to come back again later and re-accelerate hikes.

We target the 10yr Treasury yield to get back up to the 4% area; back to where it was before the SVB induced rally in bonds and sell-off in risk.

At the same time, we note that lending standards have tightened significantly in recent months. On top of that there is a growing degree of concern with respect to the commercial real estate loans portfolios being held by US banks (a post-pandemic outcome). All of this adds to stresses coming from the banking sector, stresses that can hamper macro circumstances.

Already key US forward-looking indicators, such as PMIs and ISMs, are in recessionary territory. The external backdrop is not great either, with the eurozone having moved into a state of technical recession, and China showing only a subdued re-opening oomph. The move to the recessionary environment paves the route for interest rate cuts from the Federal Reserve by early 2024.

The idea then is for 2024 to be a year with a rate cutting theme

The idea then is for 2024 to be a year with a rate-cutting theme. We see the Federal Reserve getting the funds rate down to 3% by the end of the year. Market rates will get there first. So, we see the 10yr Treasury yield heading to the 4% area in the next month, but by the end of 2023 it will be comfortably back below 4% with a view to heading towards 3%, likely overshooting to the downside.