Range-Trading Appears to Lie Ahead

Today, we receive a boatload of data headlined by retail sales for December. Other notable reports are industrial production, and the University of Michigan Sentiment survey for January. It’s not likely, however, that any of the new releases will move markets out of their recent ranges prior to the MLK holiday weekend.  In reality, most of the events with bearish potential have already passed.

With CPI, FOMC minutes, December jobs report, and the Powell confirmation hearings behind us, Treasuries should have smoother seas to navigate over the next week. In fact, after today, the data calendar next week is slim, plus the Fed will go into its quiet period before the January 26th FOMC meeting. Thus, expect more in-range trading until the meeting. That most likely means a 10-year Treasury bouncing between 1.70% and 1.80%.

Treasuries Withstand Some Rocky Seas

We mentioned above that Treasuries had navigated some pretty rocky seas this past week, most notably the steamy CPI report, and yet the selling was very modest. That seems to indicate: (1) the selling that began in the new year has priced in most of the inflation risk, and (2) investors believe the Fed will move forcefully and effectively with rate hikes in order to quell inflationary pressures. That is evident not only in the limited reaction in Treasuries to the CPI report, but also in the TIPs market and inflation breakeven rates.

Source: Bloomberg

We’ve noted the stalling out of inflation breakeven rates in recent weeks and that behavior has continued, even as nominal Treasury yields seem to have found a new, higher range for now.   What that means is real yields are rising, albeit from a negative position, and gradually tightening financial conditions. This is exactly the type of behavior the Fed is looking for in that it provides a bit of a brake to the economy, even before the first rate hike.

The most recent expectation is that the Fed will hike in March and most likely continue that hiking cadence at each quarter-end meeting through the year. So far, that expectation has investors reacting fairly calmly to the highest rates of inflation experienced in a generation. It seems that as long as the Fed moves forcefully with rate hikes this year, term premiums in longer-end Treasuries will remain limited. That’s not to say longer-end yields can’t move higher, but that any moves in that direction will likely prove to be modest to moderate.

Consumers Continue to Cast a Weary Eye Towards Inflation

One of the interesting aspects of the economic recovery has been the hesitancy of consumers to embrace that recovery. Various sentiment measures have failed to rebound to pre-pandemic levels, despite many other economic measures that have almost fully recaptured the pandemic’s negative economic impact. The graph below tracks one of these sentiment measures, the University of Michigan Sentiment Survey. As the graph shows, consumer sentiment and expectations remain well below pre-pandemic levels.

Source: Bloomberg

The  survey for January will be released later this morning, and the forecast is for consumer sentiment to tick lower to 70.0 and the expectations measure to dip to 67.0.  Thus, near-term improvement in sentiment or expectations doesn’t seem imminent. Inflation concerns are often cited as a primary reason for consumers to not fully embrace the economic recovery to date.   Luckily for the economy, this dour outlook hasn’t kept consumers from spending.

It is interesting, however, that while fixed income investors seem confident in the Fed’s ability to tame inflation, consumers are much less sure. It seems consumers will have to see real improvement in their costs for food and gas before their sentiment measures lift.

Agency Indications — FNMA / FHLMC Callable Rates

Maturity (yrs) 2 Year 3 Year 4 Year 5 Year 10 Year 15 Year
0.25 0.94 1.29 1.50 1.78 2.26 2.73
0.50 0.93 1.26 1.44 1.67 2.12 2.62
1.00 0.92 1.23 1.42 1.63 2.03 2.49
2.00 1.22 1.35 1.55 1.91 NA
3.00 1.50 1.85 NA
4.00 1.80 NA
5.00 1.77 NA
10.00 NA

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Published: 01/13/22 Author: Thomas R. Fitzgerald