Inside Markets — Bond Yields

Last week’s pullback in US equities followed some controversial Trump cabinet picks (Gaetz and RFK Jr.) that undermined confidence with the potential for contentious confirmation hearings to become a distraction for a pro-growth agenda. That pro-growth agenda was also responsible for the post-election back up in bond yields that equity investors mostly tolerated. Ten-year Treasury yields are lower this morning after last week’s failed test of the July 1 high at 4.46%. A break of 4.46% would create a small headwind for equities, but shouldn’t pose a significant threat until there’s risk of a new cycle high above 5%. Any credible challenge of the 5% level before year-end would only follow higher inflation data in our opinion. A more stimulative than expected tax proposal could also drive yields higher, but we don’t see credible details emerging before the inauguration. The team of economists from Trump’s first term was notably uncontroversial, so it’s possible that forthcoming picks in that department could re-instill confidence and restart the year-end rally.

Higher bond yields and sector dislocation from cabinet picks (Health Care on the RFK Jr nomination) may increase the near-term degree of difficulty but the broad market looks like it’s just consolidating gains/burning off overbought conditions.

The big story in bond markets may be what didn’t happen as 2, 10 and 30-year nominal yields have remained anchored below YTD peaks. It’s possible that whispers of a larger-than-expected tax package could push yields higher but Treasury prices are already at deeply oversold levels. In particular, we see limited room for 2-year yields to reprice higher in the near-term. Now at 4.28%, it would require a major shift in the Fed’s reaction function to trade materially above this level.