Get Ready

The jury is still out, but I reckon that last week’s price action provided a foundation for markets to finally get an answer to the question that’s on everyone’s mind. The sustained climb in equities and the precipitous decline in the dollar are interesting in their own right, but I am keeping my eyes on the US bond market.

The long bonds sold off steadily through the week, a move that culminated with Friday’s curveball of an NFP report—payrolls rose by 2.5 million, breezing past the consensus of a 7.5 million fall — and providing a further leap in yields. All told, the US ten-year rose by almost 30 bps last week, to just under 0.9%, and with the front-end more-or-less locked, the 2s10s and 2s5s steepened to 70 bps and 30 bps, respectively, which is the widest since early 2018.

A closer look at the chart won’t really raise any eyebrows. Sure, the curve is steepening, but it’s not like the move is unprecedented, and the curve is still overall quite flat. In the present context, however, last week’s move is a clarion call to the Fed. Will they allow (long-end) bond yields to reflect the deluge of debt issuance, and associated economic rebound, or will they, as some have suggested, put the Treasury market on a “war footing” via a yield cap?

In other words, it’s do or die for the decision on yield curve control. Of course, that’s not entirely true. The Fed has been waffling on this issue for ages, and there is no guarantee that they won’t continue to do just that. That said, I have to say that last week’s squeeze in bonds offers a very tasty and clear setup for this week’s FOMC meeting. Will the Fed let long yields run, or will they put a lid on them, either verbally, or via an outright YCC announcement?

I know that I have been harping about this question for ages, but there is a reason for that. The US government bond market is the worldʼs benchmark financial instrument, so if the men and women with the USD printing press decide on a yield cap — which is equivalent to price controls — itʼs fair to say that it would be a pretty big deal. All other global assets would be profoundly affected by such a decision, as would the response of policymakers in the rest of the world, both fiscal and monetary.

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