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10-year yield rises to 1-month high on inflation worries as CPI is released today
Treasury auctions record-sized 10-year T-note
Stocks fall as McConnell says talks are at an impasse

10-year yield rises to 1-month high on inflation worries as CPI is released today — The 10-year T-note yield on Tuesday moved sharply higher to a 1-month high and closed the day +7 bp at 0.64%. The rise in the 10-year T-note yield helped push stocks lower and the dollar index higher. In addition, gold fell sharply on heavy long liquidation pressure as real interest rates rose and made gold less attractive.

Tuesday’s rise in the 10-year T-note yield was sparked by (1) the stronger-than-expected PPI report, (2) improved U.S. Covid figures, and (3) supply overhang with this week’s massive refunding operation.

The U.S. July core PPI rose +0.5% m/m and +0.3% y/y, stronger than expectations of +0.1% m/m and unch y/y. The +0.5% m/m gain was the largest monthly increase in 1-3/4 years as prices recover from pandemic lows.

The strong PPI report helped boost the 10-year breakeven inflation expectations rate to a new 5-3/4 month high and a close of +2 bp at 1.63%. Despite the pandemic dip in the economy, inflation expectations are now only 2 bp below the pre-pandemic level of the 1.65% average seen in Q4-2019.

The rise in inflation expectations is particularly alarming for T-note investors, who are buying Treasury securities with yields so far below inflation expectations that they are guaranteed to lose money on an inflation-adjusted basis if inflation in the coming years matches current expectations. Indeed, the real 10-year T-note yield, as illustrated by the 10-year TIPS security, is currently trading at -0.96%, meaning that investors are paying the Treasury nearly 1 full percentage point simply to warehouse their money.

The consensus is for today’s July CPI report to edge higher to +0.7% y/y from June’s +0.6%, but for the core CPI to edge lower to +1.1% y/y from June’s +1.2%.

An unexpectedly strong CPI report today would likely produce new inflation worries and prompt a further rise in the 10-year T-note yield, particularly since the Treasury market is on thin ice with this week’s record-sized refunding operation.

Treasury auctions record-sized 10-year T-note — The Treasury today will sell $38 billion of new 10-year T-notes, which is a hefty $6 billion larger than the Treasury’s last refunding auction size of $32 billion in May. The 19% hike in the size of the 10-year auction may result in weak investor participation, particularly given yesterday’s sharp sell-off in T-note prices.

The Treasury will conclude this week’s $112 billion quarterly refunding operation by selling $26 billion of 30-year T-bonds on Thursday. Today’s 10-year T-note issue was trading at 0.65% in when-issued trading late yesterday afternoon.

The 12-auction averages for the 10-year are as follows: 2.45 bid cover ratio, $9 million in non-competitive bids, 5.5 bp tail to the median yield, 44.6 bp tail to the low yield, and 51% taken at the high yield. The 10-year is mildly below average in popularity among foreign investors and central banks. Indirect bidders, a proxy for foreign buyers, have taken an average of 60.0% of the last twelve 10-year T-note auctions, which is mildly below the median of 62.5% for all recent Treasury coupon auctions.

Stocks fall as McConnell says talks are at an impasse — The U.S. stock market fell on Tuesday after negative comments by Fed officials on the economy and after Senate Majority Leader McConnell said that the pandemic rescue bill talks were at an “impasse.”

There has been no contact among the top players since the pandemic-bill talks broke down last Friday and since President Trump on Saturday went ahead with issuing four executive orders. Democrats are sticking to a $2 trillion top-line bill, a $600 per week unemployment bonus, and more than $900 billion of state-local aid. Meanwhile, Republicans were sticking to a maximum bill size of $1 trillion, a $400 per week unemployment bonus, and a Covid liability shield for businesses, schools, and organizations.

The two sides are waiting to see whom voters blame for the lack of any new stimulus and whether President Trump can fully effectuate his executive orders. If there is no new Congressional pandemic deal of $1+ trillion, then there will be no new $1200 stimulus payments to individuals, no second round of PPP payments, no new aid for schools, no aid for state/local governments, and no new money for virus testing.

President Trump’s executive orders on Saturday took away much of the impetus for a deal. The markets are now afraid talks might not resume until Congress returns from its recess after Labor Day. At that time, Congress will be able to assess the state of the economy and whether there is a strong need for a new fiscal boost.

For his part, Richmond Fed President Barkin on Tuesday joined other Fed officials in calling for more fiscal support and said that the U.S. economy faces a “sinkhole.” He noted that the resurgence of the virus in recent weeks “has clearly flattened out momentum.”

One factor that could kick-start new talks is if the U.S. stock market in the coming days falls sharply on worries that the economy might sink back into recession this autumn, just ahead of the November elections. In that case, Washington politicians might find some new momentum for a stimulus compromise.

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