- 10-year T-note yield falls to new 1-3/4 year on Fed and inflation expectations
- 7-year T-note yield falls to 1-1/2 year low ahead of today’s auction
- Italian bond yields surge on new EU budget challenge
- Bank of Canada policy expected unchanged
10-year T-note yield falls to new 1-3/4 year on Fed and inflation expectations — The 10-year T-note yield on Tuesday fell to a new 1-3/4 year low and closed the day down -5.5 bp at 2.266%. The 10-year T-note yield has now fallen sharply by -26 bp since the US/Chinese trade talks essentially collapsed on May 6. President Trump over that May 5-6 weekend took umbrage at China’s proposed changes to draft trade agreement and threatened to raise the tariff to 25% from 10% on $200 billion of Chinese goods, which he then went ahead and did on May 10. Only a few days later on May 15, Mr. Trump put Huawei Technologies on the U.S. trade blacklist, potentially crippling China’s second largest technology company.
The US/Chinese trade talks in the past three weeks have essentially been suspended and no date has been set for any new talks, even though there are only a few weeks left before President Trump’s threat of a 25% tariff on another $300 billion of Chinese goods could go into effect. It seems that China does not plan to hold any more trade talks until Presidents Trump and Xi can meet to discuss the situation in Japan at the G20 summit on June 28-29. China has publicly laid out its red lines. If President Xi cannot convince President Trump to back off from those lines, then the US/China trade war will only get worse as President Trump comes up with new punishments for China.
The U.S. T-note market has reacted bullishly to the escalating US/Chinese trade war since there will be negative fallout for the U.S. economy and indeed the global economy. Market expectations for Fed easing have therefore increased as the market believes the Fed will have to bail out the U.S. economy. The federal funds futures market is now expecting the Fed to cut its funds rate target by a total of -67 bp (i.e., 2.7 rate cuts) through the end of 2020, which is a new high for easing expectations.
Meanwhile, trade woes have also caused U.S. inflation expectations to drop due to (1) the sharp decline in oil prices that has been caused by the worsening US/Chinese trade war, and (2) expectations for even weaker U.S. economic growth as the U.S. pays a hefty tax on imported goods and as U.S. exports are crimped by retaliatory tariffs. The 10-year breakeven inflation expectations rate on Tuesday fell to a new 4-3/4 month low and closed the day down -3 bp at 1.74%. July crude oil prices have fallen by -$2.76 (-4.5%) per barrel since the US/Chinese trade talks broke down on May 6, helping to push the inflation expectations rate lower.
7-year T-note yield falls to 1-1/2 year low ahead of today’s auction — The Treasury today will sell $18 billion of 2-year floating rate notes and $32 billion of 7-year T-notes. The Treasury on Tuesday sold 2-year and 5-year T-notes. The benchmark 7-year T-note yield on Tuesday fell sharply by -5.8 bp to a new 1-1/2 year low of 2.16%. The markets today will be gauging whether there is sufficient investor interest for the 7-year yield at a 1-1/2 year low yield.
The 12-auction averages for the 7-year are as follows: 2.53 bid cover ratio, $20 million in non-competitive bids, 4.2 bp tail to the median yield, and 32.6 bp tail to the low yield. The 7-year T-note is of average popularity among foreign investors and central banks. Indirect bidders, a proxy for foreign buyers, have taken an average of 61.7% of the last twelve 7-year T-note auctions, which exactly matches the median for all recent Treasury coupon auctions.
Italian bond yields surge on new EU budget challenge — The 10-year Italian government bond yield on Monday surged by +12.2 bp to 2.67% and then rose further to 2.68% on Tuesday. The spread of the Italian 10-year bond yield over the 10-year bund yield on Tuesday rose to 284 bp, which is only 3 bp below February’s 5-3/4 month high of 287 bp. However, the current Italian bond spread of 284 is still 43 bp below last October’s 6-year high of 327 bp that was posted during Italy’s turmoil with the EU last autumn over its 2019 budget.
This week’s rise in the Italian bond yield was sparked mainly by a report on Monday that the EU Commission next week may propose a disciplinary procedure against Italy over its failure to cut its debt and may fine the country 3.5 billion euros. EU Commissioner for Economic and Financial Affairs Moscovici on Tuesday tried to soften that news somewhat by saying that he does not favor sanctions and only wants to promote dialogue, although he added that the fines are an available option when necessary.
Italian Deputy Premier and League party leader Salvini used the news report to lambast the EU for threatening Italy with a fine when he said Italy is struggling to pay its bills in the first place. Separately, the markets continue to be nervous about whether Mr. Salvini is picking fights with his coalition partner Five Star with a view towards calling new elections to boost the League’s seats in Parliament. An Italian election this autumn would make a 2020 budget showdown with the EU all the more difficult.
Bank of Canada policy expected unchanged — The Bank of Canada (BOC) at its meeting today is unanimously expected to leave its policy unchanged with its overnight rate at 1.75%. The BOC still harbors ideas that its next move will be a rate hike, but the BOC at its last meeting was forced into a dovish turn by dropping its bias toward rate hikes and dropping its reference to future increases. The Canadian economy is facing an uncertain situation with the US/Chinese trade war potentially dragging down the U.S. economy, which would in turn hurt the Canadian economy. There is also substantial uncertainty about whether the U.S. Congress will pass NAFTA 2.0. President Trump has threatened to withdraw from the current NAFTA treaty on six months notice if Congress refuses to pass his NAFTA 2.0 deal, which would be a disaster for US/Canadian trade.
