Evening Brief – 02.15.24
Still Disinflationary
The US 10-year Treasury yield has been steadily rising since the beginning of February, but it gathered pace on Tuesday following higher-than-expected January U.S. inflation figures. The yield is currently trading at 4.31%, its highest level since November 29.
The inflation data also convinced the market that the Federal Reserve would push the first interest rate cut of the cycle later this year. However, the bond market disagrees, as it has for months.
The steep increase in the 10-year yield indicates a disagreement that has reached fever pitch this week. This serves as a useful reminder that in the short term, the market can and will frequently overreach (or undershoot) fundamentals.
There are various reasons to believe the 10-year yield will remain contained. Firstly, disinflation persists. Even if the most recent inflation report doesn’t immediately reflect this, a broader interpretation of inflation indices, including alternative metrics, indicates that disinflation is persisting. This implies that inflation pressures are slowing down, and this trend is expected to continue, though perhaps not consistently.
Secondly, at least for the time being, a reflationary environment does not seem likely. But the focus has shifted to the persistence of inflation at current levels and how quickly it might decrease when the Federal Reserve might start decreasing interest rates in response to these inflation dynamics.
On both points, while the market has adjusted its expectations, it may be premature to definitively declare the end of the disinflationary trend and anticipate a sharp reversal in the 10-year yield.
The outlook is subject to change based on evolving economic indicators, and a significant factor is the sentiment and expectations of consumers regarding inflation. The New York Fed reported this week that consumer expectations appear stable and relatively modest.
While historical events might provide context, current economic conditions are distinct, and a reflationary scenario akin to the mid-1970s is not currently unfolding.
However, if that assumption is incorrect, we will see evidence increase through incoming data in the coming days and weeks. For the time being, the probability is still low that a new round of reflation will begin.