A Breakthrough on Trade Can Push Treasury Yields Only So High

(Bloomberg) -- Buying the dip is more than just a lazy guest’s contribution to Thanksgiving dinner. It’s also proven an enduring trading theme for the Treasury market.

A rough start to the month threatened to dent the bond market’s stellar performance this year, but Treasury yields have almost fully reversed that climb. Yet again, the haven trade prevailed thanks to faltering progress in U.S.-China trade talks. The 10-year benchmark yield has steadied around 1.77%, down from the three-month high of 1.97% touched in early November.

The market’s sensitivity to trade developments is only getting sharper as the Trump administration’s mid-December deadline approaches for another round of tariffs on Chinese goods. But even with a breakthrough in talks, those looking for a big updraft in yields might be disappointed unless investors change their mind that inflation will remain subdued.

“If we get a push significantly higher it would have to be a resurgence in growth accompanied by a pop in inflation and weakness in the dollar, which we don’t think is quite likely,” said Gemma Wright-Casparius, a portfolio manager at Vanguard Group Inc.

Inflation expectations also set a three-month high in early November, but they remain well below the Federal Reserve’s desired level. The 10-year breakeven rate, a gauge of the market’s view on the annual pace of growth in consumer prices over the coming decade, has slipped back to 1.64%.

A firm greenback has also helped cap inflation by containing import prices. The Bloomberg dollar index is up almost 1% in 2019, building on last year’s 3.2% increase.

The Fed has made clear that it won’t raise rates without a sustained pickup in price pressures. Data Wednesday are expected to show the central bank’s preferred measure remaining well below the 2% target.

For JPMorgan Asset Management’s Iain Stealey, that backdrop is making 2% a tough nut to crack for the 10-year yield.

“It’s going to be difficult to go much higher than that without a pickup in inflation expectations,” he said.

Add it all up, and the buy-the-dips strategy looks durable, according to Wright-Casparius. She’s not alone: Investors seeing value in the 10-year have driven the yield curve flatter for two straight weeks.

Wright-Casparius sees fair value for the 10-year around 1.85%, with a quarter-point range either side. And she sees more potential for a breakout below, as “the only thing I don’t think we’ve quite completely priced in is further weakening in economic data or a total collapse in the China-U.S. trade deal.”

She’s taking cues on the economic outlook in part from the U.S. consumer, and reports around the middle of next week will show how well spending and confidence can continue to support this historic economic expansion.

The New York Fed estimates growth is tracking around an annual pace of 0.7% this quarter. The latest reading for the previous three months, also due next week, is forecast to come in at 1.9%.

What to Watch

• The data schedule is packed in a week shortened by the U.S. Thanksgiving holiday
• Key releases include the Fed’s preferred inflation gauge
  • Nov. 25: Chicago Fed activity index; Dallas Fed manufacturing activity
  • Nov. 26: Advance goods trade balance; wholesale/retail inventories; home price indexes; Richmond Fed manufacturing index; housing data; Conference Board consumer confidence
  • Nov. 27: MBA mortgage applications; GDP; personal consumption; PCE deflator; durable/capital goods orders; initial jobless claims; MNI Chicago PMI; Bloomberg consumer comfort; personal income/spending; pending home sales; Fed’s beige book
• Fed commentary is thin
  • Nov. 25: Fed Chairman Jerome Powell speaks in Rhode Island
  • Nov. 26: Governor Lael Brainard discusses the policy framework review
• On the auction block
  • Nov. 25: $45 billion 3-month bills; $39 billion 6-month bills; 2-year notes
  • Nov. 26: 2-year floating-rate notes reopening; 5-year notes
  • Nov. 27: 4-, 8-week bills; 7-year notes

To contact the reporter on this story: Emily Barrett in New York at ebarrett25@bloomberg.net

To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, Mark Tannenbaum, Nick Baker

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