A good article by Matthew on the current rate environment:
Bonds find themselves in an interesting position heading into February.
On the one hand, there’s a well-established tepid recovery narrative that coincides with gradually rising 10yr yields for the past 6 months and, more recently, mortgage rates that begun to take notice. On the other hand, several of the inputs driving those trends are open to criticism, push-back, or other intervening factors that may collectively say “not so fast” to the rising rate trend.
Econ data can bat for either team in this regard and this week brings the month’s biggest reports with ISM PMIs and the big jobs report (NFP). A unified message from the data will likely matter to the bond market, but it might be hard to tell unless those “not so fast” factors are staying silent.
For the sake of clarity, let’s identify these teams.
Team Rising Rates
- Significantly lower Covid case counts (new daily cases are roughly a third of what they were a month ago)
- Vaccine optimism and actual vaccine distribution
- The reopening of economies and re-employment of laid-off workers
- Resilient-to-stronger econ data
- Fiscal stimulus and other sources of excess bond issuance (lots of corporate bonds right now as well)
- Potential progress toward the Fed’s reflationary goals and the eventual inevitability of an attempt to taper asset purchases
Team Not So Fast
- Permanent job destruction – we’re still 10 million jobs short of pre-covid levels and Friday’s forecast calls for only 50k more. At that pace, it takes 16+ years to get those jobs back.
- Vaccine roll-out inefficiencies
- New Covid strain uncertainties
- Political gridlock (decreases Treasury issuance threats)
- Ongoing Fed support implied by lackluster job growth and stubborn reflationary impulses
- The fear of a stock market correction–one that becomes more likely if rates rise too much or too quickly
- General momentum. After all, 10yr yields have been in that linear uptrend for 6 months, making rising rates increasingly susceptible to some technical push-back.
Economic data occupies a very interesting space on both of these teams. Sure, it’s all about covid first and foremost, but covid’s market impact is really all about the economy. In that sense, econ data does more than anything to decide who wins this game.
So why don’t we see bigger reactions to the data? Simply put, even when it comes to significant reports, they’re nothing more than points scored in the middle of a very long, very close game. As long as both teams continue to score, econ data will be hard-pressed to cause a panic in the bond market. But if one team manages to dominate the momentum–i.e. multiple successive econ reports that are much stronger (or weaker) than forecast–rates would likely react accordingly.
Even then, the nature of covid and the current economic reality means that the data could still be questioned if there are current fundamental developments that logically argue that case. For instance, data could be tepid, but if covid case counts are dropping and vaccination rates are ahead of schedule, traders might trade a brighter outlook and simply wait for the econ data to confirm. Conversely, data could be on the up and up, but if something about the covid/vaccine situation deteriorates, traders could disregard near-term economic successes for fear of more lockdowns and unemployment.