By Serafino Tobia, Director of Agency CMBS Trading and Portfolio, Greystone
US Treasuries
The 10-year Treasury yield is at 4.76% as of this morning, 15 bps higher since last Monday morning (4.61%). Rates moved higher last week with the US Treasury auction of $119 billion of 3-, 10- and 30-year bonds and another unexpectedly strong US Employment Report on Friday. The bond market had already concluded that the Fed is going to skip any rate cut at the FOMC meeting at the end of January (1/29); now the bond market is figuring that the employment data supports the Fed to delay even further to see how the inflation data comes in. Additionally, the bond market has added extra spread reflecting concern over possible inflation from the new administration’s plans for tax cuts, deficit spending, and tariffs. We will get another read on inflation tomorrow and Wednesday with PPI and CPI inflation prints which can cut either way – counter the bearish narrative and support a relief rally or be that one-two punch to fuel a further sell-off.
Last Week’s Economic Data
The data last week continued to reflect a healthy labor market.
- JOLTS Job Openings Report – On Tuesday, the November JOLTS printed at 8.098 million versus 7.74 million job openings in October and higher than the forecast. The higher number indicates stronger demand for labor. The September 2024 print at 7.37 million was the lowest level since pre-pandemic (vs.12 million+ during the pandemic).
- ADP Jobs Report – According to ADP, employment gained 122,000 new jobs in December, lower than the +140k estimate and less than November’s print +146k.
- US Employment Report – The November non-farm payroll grew by +256,000 new jobs, significantly higher than Wall Street’s estimate at +165k and higher than the November print (+212k new jobs, revised). The unemployment rate moved lower to 4.1%, versus last month at 4.2%.
Fed Policy and Next Fed Funds Rate Cut
The Fed indicated after the FOMC meeting in December (12/18) that it will proceed at a slower pace of further rate cuts – the median dot plot (survey of 19 Fed officials) is for just 0.50% in total rate cuts by year-end 2025. As discussed above, we received another strong job report; this gives the Fed extra room to hold rates steady to see if inflation improves, stays sticky or moves higher. Additionally, the Fed is “policy dependent” and will want to respond to the fiscal and tariff policies of the new administration. At this point, a 0.25% rate cut at the FOMC meetings in March or May (3/19 or 5/7) is still in play. We will see a series of inflation, employment, and other economic data prints before then.
My Take on Longer Term Yields
Undeniably, investor sentiment is bearish, fueled by the Fed’s slower pace to normalize rates, a healthy jobs market, sticky inflation and concern over the Trump administration’s fiscal and tariff plans. However, I continue to think that the sell-off in rates has been overdone and that yields should move back towards 4.50%. Admittedly, it was easier to say this last week before Friday’s outsized employment report.
To my thinking, 4.25% - 4.50% 10-year yield represents fundamental value based on expected inflation at 2.25% - 2.50% plus a 1% add-on for a real yield and an additional 1% spread for term risk. With the 10-year yield at 4.76%, by definition, either (1) expected inflation or (2) term spread has moved higher.
- Expected Inflation — I don’t think expected inflation has moved substantively above 2.50%. That’s where the Fed’s summary of economic projection has inflation for this year. Further, the fear about the inflation implications of the Trump administration’s tax cuts and tariffs plans is likely overdone. Recognize that most of the new administration’s fiscal policy agenda will need the support of Congress and arguably Congress will add some fiscal discipline. Tariffs can be accomplished with the President’s executive order authority; however, the threat of tariffs may well be mostly a negotiation tactic to extract better trade terms.
- Term Spread — Since the Fed pivoted with a 50-basis point rate cut in mid-September (after a dismal +78k job growth in the August employment report), the 10-year Treasury has moved some 115 basis points the wrong way – from 3.61% closing level on September 16th to 4.76% currently. Market strategists at JP Morgan Asset Management, T. Rowe Price, Franklin Tempelton, and others are calling for a 5% 10-year yield (or higher); however, their forecasts depend, in part, on inflation with Trump tax cut and tariff policies breaking the wrong way. I’m in the wait-and-see camp and expect the term spread to improve.
Upcoming Economic Calendar
The highlight of the economic data this week will be December’s producer price index (PPI) released tomorrow and consumer price index (CPI) on Wednesday. The key data point will be Core CPI (without the more volatile food and energy prices); the market is expecting +0.2% for the month. Headline CPI is forecasted at +0.3% month-over-month. But first, tomorrow, we get the PPI print; both headline and core PPI is expected at 0.3% for the month. This week, we also see Retail Sales figures on Thursday and other housing and economic data.
The information provided in this email, including, without limitation, any opinions, predictions, forecasts, commentaries or suggestions, is for informational purposes only and should not be construed to be professional or personal investment, financial, legal, tax or other advice.