There's something that is not quite adding up in trading this week. We've had two hotter-than-expected US inflation readings in the space of two days, and yet Treasury yields are actually moving lower instead of higher. Now, that is not quite the reaction you would expect from the bond market especially after having seen yields threaten multi-decade highs in the past week or so.
US headline CPI climbed to 3.7% annually in September with core CPI pushing up to 2.6% annually. Meanwhile, producer prices jumped up by 1.3% on the month in September - marking the biggest increase since March 2022. At first glance, those are hardly comforting numbers for the Fed to be dealing with. And that is especially the case with markets already bracing for another rate hike before year-end.
And yet, we're seeing 10-year Treasury yields fall back from the initial post-CPI high of 5.30% all the way down to around 5.10% in the aftermath. So, what gives?
One plausible explanation is that there is a possibility that bond traders are starting to look beyond the immediate inflation problem and becoming more concerned about what all of this means for economic growth down the road.
Higher inflation pressures means that the Fed may have to stick with their "higher for longer" approach. And that means more expensive mortgages, tighter financial conditions for businesses, and greater pressure on household spending. As it would turn out, the cure for high inflation could end up doing more damage to the economy itself.
And if traders are shifting their focus back towards anticipating weaker growth in the future, that could be what is leading to buying in long-end Treasuries even with inflation remaining comfortably high. Yes, the argument here is essentially a return back to the classic flight to safety in the bond market. And that buying pushes bond prices higher and yields lower.
The fact that the stock market is also coming under scrutiny is only adding to this narrative. As tech shares are bearing the brunt of the pain, it is starting to unmask some vulnerabilities in the broader stock market. And again, that might be the trigger in getting traders to go back to chasing safe haven assets i.e. bonds once more.
Of course, I wouldn't go as far as declaring that the bond market has suddenly completely abandoned its inflation worries. But if yields continue to fall even as inflation remains stubborn, that would strengthen the argument that growth worries are starting to make their way back into the equation.
Having said that, 10-year Treasury yields sticking above 5% is still not a signal that the bond market selloff is over. Even at these levels, borrowing costs are still high enough to choke off the economy. However, it is still worth taking note of what the bond market reaction this week is telling us. That being the economy may eventually struggle to withstand the measures needed to bring inflation back down, and traders are also starting to take notice.
This article was written by Justin Low at investinglive.com.