Bond Traders Dare to Bet on a Fiscal Bridge to Vaccine

(Bloomberg Opinion) -- Federal Reserve Chair Jerome Powell spent so much time in front of the Senate Banking Committee on Tuesday talking about bridges, you’d be forgiven for thinking that “Infrastructure Week” had arrived at last.

Powell has turned to his tried and true analogy time and again over the course of the past several months in making the argument for additional fiscal stimulus from Congress. His point is that unemployed workers, small businesses and state and local governments need money now to get through the next few months, during which many areas of the economy will be closed because of the coronavirus pandemic. Powell acknowledged that the latest vaccine developments are “very positive for the medium term” but cautioned that the path directly ahead could be rocky.

“There are parts of the economy that might need help to get that last span of the bridge in place to get to the other side of the pandemic,” Powell said. “I think a bridge is exactly the right way to think about it. We can see the end — we just have to make sure we get there.”

Treasury Secretary Steven Mnuchin, who was also at the hearing, shared Powell’s view. “The problem is now — these small businesses can’t wait two or three months,” he said. “More fiscal response is needed. What’s more important is what we can pass quickly on a bipartisan basis to target the most difficult parts of the economy.”

For the past few weeks, as every Monday seemed to bring news of yet another Covid-19 vaccine breakthrough, bond traders have remained steadfastly glum. As I wrote last week, even after the Dow Jones Industrial Average surged past 30,000 for the first time and the copper-gold ratio indicated brighter times ahead, benchmark 10-year Treasury yields stayed pinned within a tight range, unwilling to buy into the optimism that the world economy would soon emerge from the pandemic.

Powell’s long-awaited “bridge” might just be built soon. And that seems to be enough for bond traders to dare to bet on better days.

The 10-year yield rose by 9 basis points on Tuesday, the most in more than three weeks, and the bond market’s measure of inflation expectations over the next decade hit the highest since May 2019 after a bipartisan group of senators unveiled a $908 billion stimulus proposal — incidentally, at the same time that Powell and Mnuchin were providing testimony elsewhere on Capitol Hill — that included money for unemployment insurance, transportation, small businesses and state and local governments. While neither Republican nor Democratic leaders have signed on to the plan, Republican Senator Mitt Romney of Utah, one of its backers, gave a preview of the pitch to his party by noting that much of the financing would come from leftover funds from the Paycheck Protection Program and Fed emergency lending facilities.

“It sounds like you’re hitting a lot of the areas that could definitely benefit from help,” Powell told Senator Mark Warner of Virginia, a Democrat who also worked on the relief proposal. “These are areas that are going to be experiencing a challenging winter.”

In perhaps one of the clearest signs that bond traders consider fiscal stimulus a real possibility to jump-start the economy in the post-Covid era, two-year Treasury yields rose as much as 2.2 basis points, the second-largest intraday jump of the past three months, while five-year yields surged by 6.2 basis points, the second-biggest increase since June 5. Any rise in shorter-term yields is significant because the Fed has been adamant that it will keep the fed funds rate pinned near zero until the U.S. reaches full employment and policy makers see actual evidence of inflation averaging 2% over time. 

If Congress passes a fiscal aid bill in the near future, around the same time that Covid-19 vaccines start to make their way to critical segments of the population, expect bond investors to talk up the possibility of accelerating inflation again. At 0.93%, the 10-year yield is still well within its established range, and break-even rates aren’t by any means signaling rapid price growth. But if the nearly $1 trillion proposal gains momentum, expect the 10-year yield to test the 1% level that it failed to breach last month and for 30-year yields to climb toward the November high of 1.77%. The yield curve from five to 30 years may again reach the steepest since late 2016.

Meanwhile, House Speaker Nancy Pelosi delivered a new proposal for a stimulus package and Senate Majority Leader Mitch McConnell said Tuesday that he was circulating among Republicans his own revised plan, which has the backing of President Donald Trump. Neither has yet offered much in the way of details. “Waiting until next year is not an answer,” McConnell said.

For his part, President-elect Joe Biden urged Congress on Tuesday to pass a “robust package” of fiscal aid, adding that “any package passed in lame duck session is — at best — just a start” and that his transition team is working on its own proposed legislation for the incoming Congress. It’s still anyone’s guess just how receptive a Republican-controlled Senate would be to such proposals, assuming Democrats don’t sweep Georgia’s runoffs.

In the eyes of the bond market, the Senate bipartisan plan seems like the best chance for Washington lawmakers to agree to a relief package after months of bickering. It might just be a long enough and strong enough “bridge” to get Treasuries to finally buy into the optimism that has gripped just about every other corner of the financial markets.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

©2020 Bloomberg L.P.