Talking Points:
- The US Treasury sold a range of paper Tuesday, but it was the near decade high yield from the 2-year note that stood out
- Treasury yields have closely followed the implied Fed Funds rate in FF futures, but the Dollar certainly hasn't followed
- Normalizing extreme monetary policy will distort Treasuries' 'signal', but eventually the connection to risk trends will be made
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Yields In the News
For the average investor, discussions of yields are usually overlooked because they are considered too derivative to market movement to be useful. However, there are times when this particular area of the financial system finds its way into mainstream news and trading conversation. It certainly has recently. A headline premium is put on statistics that highlight markets registering the highest or lowest levels in years and an increase in activity that is otherwise extreme. The benchmark US Treasury yield has satisfied the former measure with the highest reading since August 2008 following a remarkable auction for paper of the same duration this past session. Yet, this is not a new trend. We have seen this trend to highs unfold for some time now. It is really the explanation for 'why' that has really evolved.
Why is the US 2-Year Treasury Yield at a Decade High?
There are a few factors contributing to the near-decade high in US yields that have taken over headlines from the record-breaking equity indices' run. Inflation expectations are certainly rising, but they have done so for some time with nary a second glance from global investors. More prominent in this equation is the rate speculation for the Fed. The US central bank has already put in for five rate hikes and anticipates another three this year - an unprecedented pace amongst its major peers. We seem the same response to rate forecast through Fed Fund futures. The implied yield from the December 2018 contract is at a decade high of its own and stands at 2.055 percent - close to the two-year yield. At the same time, the gains in yield up the curve is somewhat restrained. Rate hikes impact shorter-term rates, while the more longer durations find more sway from the stimulus program which is very slowly being wound down.
Rate Forecasts for Yields Versus the Dollar
Looking at the correlation between the two-year Treasury yield and implied rate from the Fed Fund futures contrast, we see a near lockstep relationship between the two. Here, interest rate forecasts carry a remarkable influence. And yet, another market milestone that historically aligns to all of this - the US Dollar - has all but abandoned the relationship. In fact, yields and the Dollar have started to develop a negative medium-term correlation - an unusual situation. What does this tell us? Are the Greenback or yields somehow 'broken' in their signal, or are there caveats to the underlying theme that are more apparent in this relationship? I believe it is the latter. While yields and yield forecasts are rising, they do so from an extremely low starting point. Furthermore, speculation has already ramped up the relative strength/weakness of the Dollar versus its counterparts. These are considerations that distort what we can learn from these markets.
Keep An Eye on the Yield - Risk Trend Bridge
While it may be true that Fed policy is generating a hefty discrepancy in influence between Treasury yields and the Dollar, this is a gap that is unlikely to remain for long. Eventually, risk appetite either ramps up to the point that even the low overall historical yield that the US rate represents is sought after by a hungry crowd, or risk aversion kicks in and everything aligns. Risk trends are the universal mover and great equalizer, but we have not seen a steady and driving move in these deep current yet (and that assessment includes the sharp slide just weeks ago). Yet, risk trends will inevitable catch traction, and I believe that the heavy distortion in monetary policy over the years with the resultant skew in risk trends will make this particular theme one of the most capable systemic catalysts out there. We discuss the importance of watching yields and what it may signal for traders in today's Quick Take Video.
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