Morning Notes — Back to Curve Flattening

Optimism for a bipartisan/White House infrastructure package could be premature, but the headlines return markets to the ‘inflation/Fed policy mistake’ narrative.  Five-year Treasury yields are higher and 30-year yields decline with the 5/30 spread retesting strong technical support at ~120bps.  Given the news and flatter curve, we’d expect the relative performance of growth vs. value sectors to be wider than it is with the S&P 500 Value ETF (IVE) actually higher on the day.  The apparent disconnect reflects the early-cycle nature of the recovery and the unsettled debate on pricing pressures once supply constraints ease. The nuanced hawkish pivot in last Wednesday’s FOMC warranted some repricing, but the extent of curve flattening was exaggerated by positioning dynamics that now look exhausted.  The term ‘pain trade’ refers to markets’ historical propensity to move in a direction that causes the greatest amount of pain.  This happens when non-consensus catalysts exaggerate moves in crowded trades. The most crowded trade at the moment is long Tech and a narrative that shifts to higher real yields (nominal yields minus inflation) would be non-consensus.  Inflation expectations can stay subdued and bond yields can rise as markets become convinced of the sustainability of the cycle.  It’s premature to price-in rate hikes, when asset purchase tapering hasn’t even been determined. Late-cycle dynamics shouldn’t be present in markets now and tapering longer-dated bond purchases would steepen the yield curve.