- 10-year T-note yield remains locked in a narrow range ahead of today’s auction
- 10-year T-note auction to yield near 0.71%
- U.S. CPI expected to fall
10-year T-note yield remains locked in a narrow range ahead of today’s auction — The 10-year T-note yield has been locked in a remarkably narrow range over the past six weeks despite the massive turmoil in the global economy. The 10-year T-note has stepped down to a new range of 0.54%/0.78% from the pre-pandemic range of 1.50%/2.00% seen in the latter half of 2019.
The 10-year T-note yield has been trading in an extremely narrow range in the past six weeks because (1) the market is expecting the funds rate target to remain locked at its current level for at least the next three years, and (2) the Fed has been steadily buying T-notes on a daily basis since the crisis began, which has prevented yields from rising much even as the U.S. and global economies take some initial steps towards reopening.
Market expectations for the Fed to keep its funds rate target unchanged at 0.00%/0.25% for at least the next three years is helping to keep long-term Treasury yields pegged at historically low levels. The current 10-year T-note yield of 0.71% is currently 66 bp above the effective federal funds rate of 0.05%, which is a substantially narrower spread than the 161 bp average seen since 2000. There is nothing that prevents the 10-year T-note yield from falling below the funds rate target, although that usually only happens when the Fed raises the funds rate to relatively high levels to address high inflation and/or an overheated economy.
The federal funds futures market reflects market expectations that the Fed will not raise its funds rate target for at least three years. The March 2023 federal funds futures contract, which is the longest-dated futures contract that is currently trading, closed yesterday at a yield of 8 bp, which is just 3 bp above the current effective federal funds rate of 5 bp and is actually below the current target mid-point of 12.5 bp (target range 0.00%/0.25%).
Some of the 2021 federal funds futures contracts last week turned slightly negative by -3 bp. However, two Fed officials on Monday reiterated the Fed’s long-held view that negative interest rates are not appropriate for the U.S. and the 2021 contracts yesterday moved back up to zero. Chicago Fed President Evans on Monday said he “doesn’t anticipate using negative rates in the U.S.” Meanwhile, Atlanta Fed President Bostic said, “I am not a big fan of going into negative territory.”
The Fed’s general position on negative interest rates is that they have not worked well in Europe and Japan. The main concerns are that negative rates hurt bank profitability as well as individual savers, and do not necessarily boost bank lending. However, if the Fed in the future should face similar or worse conditions as those in Europe and Japan, Fed officials might change their tune and see little choice but to cut the funds rate into negative territory.
T-note yields are also at extremely low levels due to the sharp drop in inflation expectations. The 10-year breakeven inflation expectations rate is currently at 1.12%, reflecting market expectations for inflation over the next 10 years to remain far below the Fed’s +2.0% inflation target. The partial shutdown of the global economy has hammered prices across the board, from commodities, to components, to finished goods. The sharp hit to the global economy is likely to keep inflation at depressed levels for at least the next several years.
10-year T-note auction to yield near 0.71% — The Treasury today will sell $32 billion of 10-year T-notes, which is up by a hefty $5 billion from February’s $27 billion size. The Treasury will then conclude this week’s $96 billion refunding operation by selling $22 billion of 30-year T-bonds on Wednesday, up by $3 billion from February’s size of $19 billion.
The Treasury was forced to boost the size of this week’s quarterly refunding operation by $12 billion to $96 billion from February’s $84 billion due to the massive increase in the Treasury’s borrowing requirement caused by the pandemic. The Treasury is also bringing the 20-year T-note out of mothballs and will sell $20 billion of 20-year T-notes next Wednesday to help with the Treasury’s funding requirement.
The Treasury last Monday said that it will have to sell a net $3 trillion worth of Treasury securities just in Q2 in order to cover the massive budget deficit. The Treasury said it expects to sell another $677 billion of net new debt in Q3.
The expected $3 trillion surge in the national debt in Q2 would push the national debt from the current level of $25 trillion up to a new record high of $28 trillion by the end of September. The new debt level would be up by about $8 trillion (+40%) since President Trump took office due to the combination of long-term chronic overspending, the 2018 tax cuts, and now the pandemic debacle.
U.S. CPI expected to fall — The consensus is for today’s Apr CPI to fall by -0.8% m/m, adding to the -0.4% m/m decline seen in March. On a year-on-year basis, the CPI is expected to drop to +0.4% y/y from March’s +1.5%.
The drop in the CPI will not be due solely to food and energy since today’s April core CPI is expected to fall by -0.2% m/m, adding to March’s decline of -0.1%. On a year-on-year basis, the April core CPI is expected to drop to +1.7% y/y from March’s +2.1%.
The Fed’s preferred inflation measure is weaker than the CPI and is also headed lower. The PCE deflator in March fell to +1.3% y/y from Feb’s +1.8% and the core deflator eased to +1.7% y/y from March’s +1.8%. Those rates remain well above the market’s expected 10-year inflation rate of +1.12%.
