There are many theories swirling around as to why the US 10yr yield did an about-turn on Friday, post-payrolls. It had initially lurched towards 4%. But in a flash, it was heading back towards 4.25%.
We rationalise this based on two factors. First, the curve remains very inverted, with longer tenor yields anticipating falls in official rates in the future. That’s a normal state of affairs. But as long as the economy continues to motor along, the wisdom of having many rate cuts at all is being questioned by the market. Less future rate cuts raise the implied floor being set by the Fed funds strip. That floor continues to edge higher. That’s the second (and related) rationale.
Friday’s payroll report was not one that suggested anything had broken. Rather, it hinted at more of the same ahead. There are lots of stories floating around about the rise in the oil price and heavy primary corporate issuance, but we’re not convinced they are the dominant drivers. They certainly push in the same direction, but that’s all – contributory rather than driving.
Until activity actually stalls, there is no imminent reason for the Federal Reserve to consider rate cuts, and as that story persists, the floor for market rates is edging higher and becoming more structural at higher levels. In that environment, the only way for the curve to dis-invert is from longer maturity yields coming under rising pressure as shorter-tenor ones just hold pat.
Something will break eventually, but so far it hasn’t. The path of least resistance therefore remains one for a test higher in longer tenor market rates.