- 2-year T-note yield likely to stay mired near current levels, particularly if Fed adopts yield-curve control policy
- 2-year T-note auction to yield near 0.195%
- U.S. Markit manufacturing PMIs expected to show continued recovery
- Eurozone manufacturing PMI expected to increase for second month
- U.S. new home sales expected to show a second month of recovery
2-year T-note yield likely to stay mired near current levels, particularly if Fed adopts yield-curve control policy — The benchmark 2-year T-note yield so far in June has been mired in the extremely narrow 6.7 bp trading range between 0.167% and 0.234%. The 2-year is currently trading near the middle of that range at 0.192%.
The 2-year T-note will likely remain mired near that range for at least the remainder of this year and likely into 2021 since the market is discounting a 100% chance that the Fed will leave its funds rate target range unchanged at 0.00%/0.25% at least into 2023. Without any change in the funds rate, the 2-year T-note is not likely to show much movement.
The 2-year T-note will definitely remain locked near current levels if the Fed moves ahead with some type of yield-curve control policy later this year, as many analysts expect. The Fed is still in the early stages of discussing that policy. If the Fed moves ahead, it is likely to try to target the yield curve only out to 2 years or 5 years because the 10-year and 30-year yield levels would be too hard to control.
The BOJ has been successful in targeting the 10-year JGB yield at zero percent with a range of +/- 0.20%. However, the Japanese economy and financial markets are not as large as those of the United States. The Fed would probably get itself into a losing battle with the markets if it were to try to peg the 10-year T-note yield at some level, such as 0.75% or 1.00%.
When central banks set hard targets, they are often just setting themselves up to fail. Well-known examples are when George Soros reportedly made a billion dollars busting the Bank of England’s sterling ERM peg in 1992, or when the markets blew through the Swiss National Bank’s Swiss franc peg in 2015.
If the Fed were to set a peg for the 10-year T-note yield, the Fed would have difficulty controlling that peg if there were a big change in the outlook for the economy or inflation. For example, if the markets were to start pushing the 10-year T-note yield higher because of increased inflation expectations, then the Fed would be forced to start buying large quantities of 10-year T-notes to support T-note prices. The Fed’s T-note purchases might only worsen inflation expectations and push 10-year T-note yields even higher. For this reason, the Fed is likely to stick to targeting only short-term yields since those yields are stuck more closely to the funds rate, over which the Fed has nearly full control.
2-year T-note auction to yield near 0.195% — The Treasury today will sell $46 billion of 2-year T-notes, kicking off this week’s sale of $154 billion of T-notes. The $46 billion size of today’s 2-year T-note auction is up by $6 billion from the $40 billion size that prevailed during 2019 and early 2020 before pandemic expenses caused the federal government’s budget deficit to explode.
Today’s 2-year T-note issue was trading at 0.195% in when-issued trading late yesterday afternoon. The 12-auction averages for the 2-year are: 2.60 bid cover ratio, $159 million in non-competitive bids, 3.2 bp tail to the median yield, 32.7 bp tail to the low yield, 40% taken at the high yield. The 2-year T-note is the second least popular security among foreign investors and central banks behind the 3-year T-note. Indirect bidders, a proxy for foreign buyers, have taken an average of only 50.4% of the last twelve 2-year T-note auctions, which is well below the median of 61.5% for all recent Treasury coupon auctions.
U.S. Markit manufacturing PMIs expected to show continued recovery — The consensus is for today’s June Markit U.S. manufacturing PMI to show a sharp +11.0 point increase to 50.8 and the services PMI to show a +10.5 point jump to 48.0. Business confidence is generally improving as the lockdowns end, although confidence at a micro level depends on whether a business operates in one of the highly troubled sectors of the economy, such as travel, restaurants, or entertainment.
The expected increase in the manufacturing PMI above 50.0 would be a welcome development but needs to be taken with a grain of salt since sentiment has only improved relative to the horrendous levels seen during the lockdowns. The U.S. manufacturing sector is a long way from a full recovery as seen by the fact that U.S. manufacturing production in May plunged by -16.5% y/y.
Eurozone manufacturing PMI expected to increase for second month — The consensus is for today’s June Markit Eurozone manufacturing PMI to show a +5.1 point rise to 44.5, adding to May’s +6.0 point rise to 39.4. The Eurozone manufacturing PMI rebounded higher by +6.0 points from April’s record low of 33.4 (data since 2001).
U.S. new home sales expected to show a second month of recovery — The consensus is for today’s May new home sales report to show an increase of +2.7% to 640,000, adding to April’s +0.6% increase to 623,000. New home sales plunged by a total of -21.1% in Feb-March, but then rebounded slightly by +0.6% in April and is now expected to increase of +2.7% in May. New home sales are showing some surprising strength, apparently because people are out buying new homes to get more space for working at home or to escape from multi-family dwellings during the pandemic.
The surge in home-buying interest is seen by the fact that the MBA mortgage purchase sub-index has surged by +77% in the past nine weeks and has hit a new 11-1/2 year high. The low mortgage rate is also sparking home purchases by people who still have a job. The 30-year mortgage rate last week fell to a record low of 3.13% (data since 1971).
