Opinión de experto 

Where next for US Treasuries after their rapid recent moves?

Treasury yields have fallen substantially since their peak in late-March, with the most recent leg of the decline occurring at a particularly fast pace. On the face of it, this is difficult to square with the interpretation that the June Federal Open Market Committee (FOMC) meeting delivered a more hawkish outlook than the market expected.

While we believe that the market’s positioning, and liquidity are likely to have exacerbated the speed and magnitude of recent moves, we are careful not to be dismissive of the importance of the change in fundamentals.

In our thematic investment framework, economic momentum, rates of change and turning points are key. We remain confident that the growth outlook for the next 12-18 months looks good. The rise of the Covid-19 delta variant is a reminder not to be complacent, but high consumer savings, ongoing global vaccinations and still significant policy support remains a solid combination.

We do believe, however, that we are likely past the peak in global growth momentum, especially in the manufacturing and goods sector, and that the pace of improvement will moderate from here. In the past, this has tended to prove supportive of US Treasuries, with a peak in momentum often coinciding with a peak in Treasury yields.

Have US Treasury yields peaked (for now)?

For Treasury yields, this change in the “second derivative”, or rate of growth matters, both in terms of absolute levels of yield and the shape of the Treasury curve (which plots the yields of bonds at different maturities).

Using the global manufacturing purchasing managers’ index (PMI) as an indicator of economic momentum, we can see that there are many instances in the past 25 years where, when momentum wanes, Treasury yields peak. We can also see that this can occur even if the absolute level of the PMI and global growth remains strong. 

US-yields-curve-versus-policy-rate-leading-indicator.png

This is not true in all circumstances, as the chart demonstrates, and here the role of the curve (5-year to 30-year) is important. The occasions where a peak in global economic momentum is not followed by a peak in 10-year Treasury yields tend to be when the Federal Reserve (Fed) is either on or approaching a hiking cycle.

When the Fed increases interest rates, this leads to higher Treasury yields, driven by the shorter maturity part of the curve, and meaningful curve flattening (where the difference between shorter and longer-dated yields falls).

What are the implications of this?

With the Fed having turned more hawkish in our view, a combination of slowing global economic momentum and a more engaged central bank should both continue to see flattening pressure on the US curve. It will also likely reduce the demand for protection from high inflation risks, for instance through inflation-linked government bonds.

This inflation may not come through anyway, or the Fed will respond more forcefully to any early signs that it is likely to do so. Longer-term disinflationary forces such as demography, high debt levels and technology remain intact and in some cases strengthened as a result of the pandemic.

We therefore see positioning on the curve as presenting better opportunities, rather than taking outright positions on the direction of yields. We also turn more cautious on US breakeven inflation (market-based inflation expectations).

What are the risks to this view? The first would be for economic momentum to slow down so dramatically that the Fed would have to disengage again and turn far more dovish, leading to a so-called “bull-steepening” of the yield curve (where shorter-dated yields fall). We do not see this as likely, but we continue to monitor labour market improvement and broad financial conditions as key areas to watch here.

The other major risk to our view is significantly higher yields, led by intermediate and long-end bonds. This would require further impetus to global growth momentum, or clearer signs that much higher inflation will persist, compared to pre-pandemic, and that the Fed would tolerate this.

This scenario becomes much likelier in the event of clearer signs of fiscal dominance. In other words, where fiscal policy not only remains supportive (which is our base case), but becomes increasingly so, with little to no offset to this policy loosening from the monetary side. We do not see this as likely but we continue to watch developments on the fiscal policy front carefully.