Conflict Of Interest (rates): 10-year Treasury Yield Highest in Almost Two Years

This was all following May 29, 2018, too, a day in the global “bond market” which had left no doubt collateral conditions had already become seriously strained; the monetary tightening exclamation point on all of the above.

Clear dollar shortage stuff, one after another after another.

Yeah, they did. Not only that, after having reached a high on May 17, the 10-year would climb further to its highest in seven years by early October. You might remember those days, it was in all the newspapers, splashed across the internet in every form of its mediums.

Obviously, none of it was true; not the bond “bull” bull, nor all the scattershot analysis thrown around, including a whole library of the same such commentary beyond the tiny sample reproduced (easily) above.

Barely over a month later, it all went downhill – literally, in the case of bond yields as well as the global economy.

So what did happen in 2018? How can bond yields still go up despite all those nasty things listed at the outset? And what might that episode three years ago tell us about our current markets and global situation?

First, always remember yield curve dynamics; the Treasury curve, like any other, isn’t monolithic.

In addition to nominal yields and the curve level, you always, always need to pay close attention to the shape – on the whole as well as in discrete parts – and how the profile changes over time. This is a dynamic monetary/financial/economic universe, and the curve distorts with meaning and purpose hardly anyone nowadays seems able to properly decode.

Though they are related, and do share some common factors, the balance of those can be quite different such that there are almost two curves operating simultaneously. The one at the front is most heavily inclined by monetary alternatives, and that money-like influence continues out into the middle of the notes – up to around the 5-year maturity (for a more detailed and complete description of these inner workings, click on the link above).

From the 7-year note on out to the long bond end, this is Irving Fisher’s territory, the land of inflation and growth expectations as only somewhat predisposed by the cross-currents and perceptions of those front-end conditions.

What was happening throughout 2018 was the yield curve splitting in two. On the one side, up front, the Fed and its federal funds target along with the various reserve programs (RRP, IOER) offering money alternatives via that set of policies. According to Janet Yellen then Jay Powell’s FOMC, they believed like all the media articles above the country was about to get itself into inflationary trouble.

It was becoming too good, they reasoned.

To head off that “danger”, rate hikes (as well as QT, but that’s a somewhat related tangent not necessary to go over today). For the Treasury curve, it would mean upward nominal pressure from below, from the shortest run.

While all that was taking place in the short curve, the long end outright resisted the pressure even as yields here moved up, too. That was the back end squeeze, or flattening, competing narratives being played out in the whole curve’s shape. The overall shape flattened even as rates front to back rose because, Irving Fisher, growth and inflation expectations beyond any temporary short run Fed influence were not matching up with the Fed’s projections for those rate hikes.

This is where all those dollar shortage factors I cited at the outset had come into play.

This had meant up to October and early November 2018, the yield curve would rise in nominal level while at the same time flattening dramatically. The future before that point was still undecided as to which curve, front or back, would win out.

Right here is where the landmine comes into it, thus why I place so much emphasis on it. Time after time, the landmine has proved to be the moment when these conflicting viewpoints get settled. To date, they’ve always been settled to the long end’s doubts (which simply means long end doubts about deflationary risk and potential become just deflation).

After that point, the whole thing is united once again as it collapses even up in the front (December 2018’s inversion).

You have probably heard that today, January 7, December’s Payroll Friday, the UST 10s closed up trading at 1.76%, the highest yield in nearly two years!! The media is again ablaze with BOND ROUT!!!!!, the new high being heralded as the latest definitive sign of the bond market giving up and coming around to the inflation-red-hot-economy Jay Powell’s FOMC is once again using to justify its hawkishness.

Like 2018, however, the yield curve has become similarly split and for all the same reasons. Over the past few weeks, the front end (out to the 5s) has been influenced by first the hawkish resolve (lots of rate hikes are coming!) before more recently having judged the omicron scare as little more than overkill.