- Inflation expectations reach 4-1/2 month high but 10-year T-note yield remains steady
- Key Washington meetings today on new pandemic rescue bill
- EU leaders agree on 750 billion euro Recovery Fund
Inflation expectations reach 4-1/2 month high but 10-year T-note yield remains steady — The 10-year breakeven inflation expectations rate on Monday posted a new 4-1/2 month high of 1.47%. The breakeven rate measures the difference between the nominal and TIPS 10-year T-note note yields.
The 10-year breakeven rate has moved sharply higher by a full percentage point from the low of 0.47% seen during the worst of the pandemic scare in March. The current 10-year breakeven rate of 1.47% remains well below the Fed’s inflation target of 2.0%, which means the Fed needs to maintain its stimulative policy. However, the breakeven rate is only 18 bp below the average of 1.65% seen in Q4-2019 before the pandemic emerged as a major problem in early 2020, showing that inflation expectations are not currently much lower than they were before the pandemic.
A key reason for the rise in the 10-year breakeven rate is the recovery in WTI crude oil prices to the current level of $41 per barrel from the spike down to negative levels in April. Even after that recovery, however, oil prices are still well below the pre-pandemic average of $57 per barrel seen in Q4-2019. The 10-year breakeven rate typically shows a strong correlation with crude oil prices since (1) oil can be considered a proxy for commodity demand in general, and (2) oil is a key expense input for corporate America with an influence on final prices (e.g., fuel and transportation costs).
The 10-year breakeven rate has also been rising on optimism about the ability of the global economy to muddle through the pandemic and generate enough economic growth to support the prices of goods and services. The recent U.S. pandemic statistics have been dismal, but states are doing everything they can not to return to the days of blanket stay-at-home orders.
Also, there is optimism in the market about the scientific progress on Covid vaccines and hopes that effective vaccines will be widely available by early to mid-2021, which would have the ability to end the pandemic if there aren’t too many people who refuse to get a Covid vaccination.
The rise in 10-year inflation expectations to a 4-1/2 month high is a bearish factor for T-note prices. However, T-note prices have shaken off the higher inflation expectations and continue to move sideways in an extremely narrow range on support from the Fed’s QE buying and on expectations that the Fed will keep the funds rate locked near zero for at least the next two years. T-note prices also have support from the resurgence of the pandemic in the U.S., which means a slower recovery and therefore pressure on the Fed to maintain its monetary largesse for longer.
Key Washington meetings today on new pandemic rescue bill — Treasury Secretary Mnuchin and White House chief of staff Meadows are scheduled to meet today with Senate Republicans to pitch the White House version of a new pandemic rescue bill and get an idea of what Senate Republicans will accept in a Republican plan. President Trump wants a payroll tax holiday, which has little to no support from anyone on Capitol Hill from either party. Meanwhile, Senate Republicans want $25 billion for virus testing and liability protection for businesses.
Senate Majority Leader McConnell is planning to release a Republican rescue bill later this week totaling about $1 trillion after the White House and Senate Republicans settle on a common plan. Republican talks kicked off yesterday with a meeting at the White House among President Trump, White House chief of staff Meadows, Treasury Secretary Mnuchin, Senate Majority Leader McConnell, and House GOP leader McCarthy.
There will be another key meeting this afternoon as Treasury Secretary Mnuchin meets with House Speaker Pelosi and Senate Minority Leader Schumer. A final deal, if there is one, will likely be made once again between Treasury Secretary Mnuchin and Speaker Pelosi. Senate Republicans a month ago were downplaying the chances of another rescue bill. However, they have been forced to the table by the resurgence of the virus, continued partial shutdowns across the country, and massive unemployment.
Washington is under pressure for more support since previous support measures are running out, which would likely put the economy back into a big hole just ahead of the November election. The $600 per week unemployment bonus expires this weekend. PPP money is running out for many businesses and is resulting in new layoffs. Also, the moratorium will expire this Friday for renter evictions from federally-insured apartment buildings.
EU leaders agree on 750 billion euro Recovery Fund — EU leaders late Monday night finally agreed on a 750 billion euro EU Recovery Fund after four days of hard bargaining. EU leaders on Monday night wrapped up the details of an agreement after reaching agreement early Monday morning on the key issue of grants to troubled countries.
The Recovery Fund will have 390 billion euros of grants, with the remainder of the 750 billion euro fund available as low-interest loans. Germany and other nations initially pitched grants at 500 billion but were forced to trim that to 390 billion euros by the so-called Frugal Four (the Netherlands, Austria, Denmark, and Sweden), which objected to what they viewed as give-aways without enough strings attached.
The peripheral Eurozone bond markets on Monday were encouraged by the reports of major progress towards a deal. The spread of the Italian 10-year government bond yield over bunds on Monday fell sharply by -5 bp to a new 5-month low of 156 bp.
