What’s driving the rout in bonds

US 10-year Treasury yields are now up 21 basis points from the PCE lows and you have to wonder: What would it look like if Friday’s inflation data had been bad instead of good?

Yields are now at a one-month high and rising across the curve; which is helping to boost the US dollar.

Why?

1) Quarter end

It’s always tough to read moves around quarter end. At the start of April, we also saw a big move up in yields, with a rise of 15 basis points on the first day of the quarter that continued for a total of 51 basis points to a quarterly high of 4.74% in late April. There are always quirks around the turn of the quarter and that makes for a tough read.

2) Japanese selling

We know that Norinchukin Bank will be selling $63 billion in Treasuries in the year ahead but we don’t know what the Ministry of Finance is planning in terms of yen intervention. I’ve heard arguments on both sides of whether they need to sell Treasuries to boost the yen but it’s certainly a risk and something people are talking about with USD/JPY at 38-year highs and a new currency chief installed.

3) Stagflation

You can always craft a fundamental narrative but I find this one to be a struggle because it’s accelerating in the past two trading days despite US data saying the opposite. The main thinking is that hot Canadian and Australian CPI numbers are a precursor to something similar in the US. But — if anything — I would expect the market to look beyond high inflation to a growth-sapping period of too-high rates. In any case, make your own conclusions.

4) Politics

This is a compelling illustration:

What’s changed since Wednesday when the bond move really accelerated? The main thing may have been the debate. Now plenty of people will argue that debates don’t matter but I’ve never seen this kind of a reaction to a US debate and it fits in perfectly with a Republican sweep.

All the TV talk is always about the Presidency but whether or not it includes a sweep is much more important for financial markets and that will continue to be the case as the House holds the purse strings.

The political argument is the one fixed income analysts at BMO are making:

“The selloff remains a function of the economic
implications from a potential Trump victory in November and there isn’t
anything immediately on the horizon that would suggest one should fade the bear
steepener,” they write today.

5) Politics Part 2

The US isn’t in a vacuum here. Plenty of eyes are on France and 10-years there are the highest since November on a belief that both the far right and far left will spend more.

The far right performed worse than expected at 32% vs 36% in polls but I wonder if the market is struggling to sort through the second-round uncertainty.

If you look at the platforms, there is some heavy spending from Le Pen. I think this underscores that the old paradigm of the ‘fiscal conservative’ is dead in markets. I’d argue that’s been true for awhile but might become true again in a hurry if the bond market punishes spending, like it did to Liz Truss. The thing is, the burden of overspending will probably be borne on non-US countries even if it’s the US spending, because of the special status of the dollar.

6) China

This is mixed in with politics but there’s an idea that China will really have to abandon bonds if a Trump administration ratchets up the tariffs. Now I don’t think the market is taking some of the talk about tariffs too seriously in an election campaign but you can’t rule it out and there’s clearly a schism that’s turning into an unbridgeable chasm. Whether that turns into a trade war or a real war is a real concern but we’re certainly not headed in the right direction.