- 10-year T-note yield sees upward pressure from Fed and improved economic data
- 10-year T-note auction to yield near 2.38%
- U.S. import prices expected to keep some upward pressure on overall U.S. inflation statistics
- EIA crude oil inventories expected -2.0 million bbl
10-year T-note yield sees upward pressure from Fed and improved economic data — The 10-year T-note yield on Tuesday rose to a new 5-week high of 2.414% and closed the day +1.1 bp at 2.398%. The 10-year T-note yield in the past 3 weeks has risen by a total of +25 bp since posting a 6-month low of 2.16% in mid-April. The 10-year yield is up by a hefty +58 bp from the pre-November-election level of 1.83%.
The 10-year T-note yield has been rising for the last several weeks due to (1) hawkish talk from Fed officials that make it clear that the Fed currently intends to go through with its plans for two more rate hikes this year and a change in its balance sheet policy by “later this year,” (2) expectations for a rebound in U.S. economic growth from the weak Q1 after April payrolls rose +211,000, and (3) the increased possibility that Republicans may be able to execute their growth agenda after the House was able to pass an Obamacare repeal-and-replace bill. The T-note yield is also seeing some temporary upward pressure this week on supply overhang amidst this week’s $62 billion Treasury refunding operation.
T-note yields have also moved higher because of reduced safe-haven demand after centrist Emmanuel Macron won the French presidential election and removed the Frexit threat posed by Marine Le Pen. The German 10-year bund yield has moved sharply higher by +27 bp in the past 3 weeks to a 1-1/2 month high of 0.43%, giving European investors more attractive domestic yield opportunities and reducing their incentive to buy U.S. T-notes.
The T-note market in the past several weeks has become increasingly convinced that the FOMC will raise the funds rate by another +25 bp to 1.00%-1.25% at its next meeting on June 13-14. The market is discounting about a 90% chance of a rate hike at that meeting, according to the federal funds futures market.
If the Fed does in fact raise interest rates at its June meeting, then the Fed will have plenty of time for this year’s third rate hike at one of its last four meetings on the year. In fact, if the Fed raises rates in June, then it would actually have room for a total of four rate hikes for the year, if that becomes necessary, with rate hikes in Sep and Dec. However, the Fed is not likely to raise rates that quickly, if only because it wants to leave some room to announce a change in its balance sheet by later this year. The Fed is being very cautious about its balance sheet exit strategy so that it doesn’t spark another taper-tantrum episode. The markets thus far have shown little concern about the Fed’s balance sheet exit but that could change quickly as the day comes closer for when the Fed will step aside as a significant buyer in the Treasury market. The Fed is currently a significant buyer in the Treasury market since it is currently buying new securities to replace maturing securities in its portfolio.
The main factor holding down Treasury yields at this point is tepid inflation expectations. The 10-year breakeven inflation expectations rate is currently at 1.86%, down sharply from the post-election peak of 2.09%. Inflation expectations have cooled due to the slow Republican agenda and the recent sharp drop in oil and commodity prices.
10-year T-note auction to yield near 2.38% — The Treasury today will sell $23 billion of 10-year T-notes. The Treasury will then conclude this week’s $62 billion quarterly refunding operation by selling $15 billion of 30-year T-bonds on Thursday. Today’s 10-year T-note will be a new issue as opposed to a reopening of an existing issue. Today’s 10-year T-note was trading at 2.38% in when-issued trading late yesterday afternoon, which translates to an inflation-adjusted yield of 0.52% against the current 10-year breakeven inflation expectations rate of 1.86%.
The 12-auction averages for the 10-year are as follows: 2.47 bid cover ratio, $16 million in non-competitive bids, 5.2 bp tail to the median yield, 14.7 bp tail to the low yield, and 38% taken at the high yield. The 10-year is the fourth most popular security among foreign investors and central banks behind the 10-year and 30-year TIPS and the 7-year T-note. Indirect bidders, a proxy for foreign buying, have taken an average of 64.6% of the last twelve 10-year T-note auctions, which is well above the average of 60.0% for all recent Treasury coupon auctions.
U.S. import prices expected to keep some upward pressure on overall U.S. inflation statistics — The consensus for today’s April import price index is for a +0.2% m/m increase, reversing March’s -0.2% decline. On a year-on-year basis, the series is expected to edge lower to +3.6% y/y from March’s +4.2% y/y. Excluding petroleum prices, today’s April import price index is expected to show a +0.2% m/m increase, matching March’s increase. U.S. import prices have risen moderately over the past year, mainly because of higher oil prices. However, import prices ex-petroleum have also been moving mildly higher over the last year, keeping upward pressure on the overall U.S. inflation statistics.
EIA crude oil inventories expected -2.0 million bbl — The market consensus for today’s weekly EIA report is for a -2.0 million bbl drop in U.S. crude oil inventories, a +30,000 bbl increase in gasoline inventories, a -600,000 bbl decline in distillate inventories, and a +0.3 point increase in the refinery utilization rate to 93.0%. U.S. crude oil inventories have been falling in the past several weeks, a little earlier than normal from a seasonal standpoint. However, that has been offset by the fact that gasoline inventories have risen sharply in the past several weeks, transferring some of the glut from crude oil to product inventories. U.S. oil production last week rose by +0.3% w/w to a new 1-3/4 year high of 9.293 million bpd.
