Delta Variant Continues to Weigh on Growth Outlook

The market continues to take its lead from rising virus cases, both domestically and globally, and that continues to provide a bid in Treasuries as second-half 2021 growth prospects are revisited and marked lower. We take a look at what could be a catalyst for a further rally in Treasuries in the following section and then we look at some early indications that cases may indeed be peaking in the U.S. which could keep growth prospects largely intact. One thing is for sure, however, given the resilient nature of the virus making any long-term predictions has proven a fools errand.

.Finally, in our podcast this week we talk with Mark Miller, VP of High Performance Leadership for Chick-fil-A. We talk about his book, Chess Not Checkers, and the importance of growing the younger leaders in your bank. The iTunes link can be found here and the Spotify here.



One Catalyst For Even Lower Yields

Treasury yields continue to be driven lower by rising virus cases, domestically and especially globally, as expectations continue to be marked down for second half 2021 growth. While we offered our opinion last week that the marking down of growth prospects due to the rising virus cases may be too much, the subsequent dip in sentiment measures from Univ. of Michigan, to Empire Manufacturing to Philly Fed Business Outlook did signal that at least sentiment had become more cautious. Whether that change in sentiment leads to lasting changes in consumption remains to be seen, but for now the Treasury market continues to trade on that belief.


Source: Bloomberg

There remains, however, a fair amount of skepticism that these yield levels will hold.  That may be true but there does exist a catalyst to drive yields even lower from current levels. As the graph shows, much of the spring and summer rally in nominal yields (orange line) hasn’t been accompanied by a drop in inflation expectations (blue line). This has led to real yields (nominal less inflation expectation) dropping as well (white line). What if a slowdown in economic activity does occur such that inflationary expectations start to fall? All else being equal a drop in inflation expectations would lead to an increase in real yields. But all else is not equal. What is more likely to happen is that the drop in inflation expectations due to reduced growth expectations would lead to another rally in nominal yields and thereby leave real yields largely unchanged.  We’re not betting on that outcome but just to show that there does exist a very plausible scenario where yields could move lower from here.

Are Delta Variant Virus Cases Starting to Peak?

Meanwhile, the case for moderating case counts in the near future continues and that could provide the groundwork for a rethink of the marking down of growth prospects, at least in the U.S.. The graph below, from Renaissance Macro Research, identifies those states with effective reproduction rates above 1 (indicating a growing level of cases). That number peaked at all 50 states plus DC in late July/early August. It has since dropped to 32 states with an effective reproductive rate above 1. While the graph shows only increasing confirmed cases, it should start to moderate given the slowing in reproductive rates from the late July/early August experience.


The reproductive rate is a leading indicator for sure so it may take some time to actually start to see case counts recede, but it does imply a plateau may be in the near future. One caveat to expecting case counts to fall soon is U.S. schools have recently, or will shortly, reopen so it’s likely we’ll see some bounce in cases due to that exposure but that would likely be a short-term spike.

In any event, while the U.S. may see some plateauing in cases, the global story remains quite challenging especially in Australia and China. Part of the rally in Treasuries reflects not only the domestic story but a global one as well, so even if U.S. cases start to level-off and recede the global impact will likely continue to provide a bid to Treasuries at least into the fourth quarter.

Agency Indications — FNMA / FHLMC Callable Rates

Maturity (yrs) 2 Year 3 Year 4 Year 5 Year 10 Year 15 Year
0.25 0.11 0.37 0.62 0.92 1.65 2.11
0.50 0.10 0.34 0.55 0.81 1.50 2.00
1.00 0.09 0.31 0.52 0.76 1.41 1.86
2.00 0.30 0.47 0.68 1.29 NA
3.00 0.64 1.23 NA
4.00 1.16 NA
5.00 1.15 NA
10.00 NA

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Published: 08/19/21 Author: Thomas R. Fitzgerald