USD Rates: Undoing some pessimism

10Y yield climbs above 1.40%.
Eugene Leow07 Dec 2021
    Photo credit: Unsplash Photo

    Sentiment continues to be volatile with market participants deciding to undo last Friday’s pessimism. The US Treasuries curve bear steepened with 10Y and 30Y yields clawing back above 1.40% and 1.70% respectively. It also helped that equity markets had a decent day with the three major indices all in the green. We think the moves may well be exacerbated by poor liquidity and there is probably more noise than signal. At current levels, 10Y and 30Y yields are more than 20bps lower than where they were before the Omicron news hit. Clearly, there should be some demand for safety as the growth outlook in the near term is weakened. Even without Omicron risks, Delta variant cases are also rising, prompting domestic restrictions in several economies. It might take a while before growth worries recede. 10Y yields close to 1.40% is at the low end of what we think is reasonable given growth uncertainties.  

    Short-term USD rates have thus far been resilient through the tumult in longer-term rates. Despite 10Y and 30Y yields holding the bulk of their declines, 2Y UST yields are hovering above 0.6%, close to the recent peak. This suggests that market participants are still looking for Fed normalisation and are more cautious in the belly (2Y-5Y) while seeking longer-term Treasuries for insurance in case the Omicron variant proves difficult to overcome. Fed funds futures still point to two hikes by end-2022 and 6.5 hikes by end-2024. Overall, the market has shaved off about half a hike over the next few years, compared to recent peak pricing of seven hikes on 24 November

    Accelerated tapering still looks likely even as the Omicron variant has reduced the odds slightly. The hurdle for reduced QE is probably a lot lower than that for hiking rates. This week’s CPI data is unlikely to shift this view.Consensus expectations look lofty, pencilling another 0.7% MoM sa gain in November. There could be some downside risks to this headline figure given the correction in oil prices. More importantly, we would be looking at core CPI and other alternative measures (trimmed mean, sticky prices) to see if there are broad-based price pressures. In any case, we do think that we may be past peak inflation fear in the short term.   

    Eugene Leow

    Senior Rates Strategist - G3 & Asia
    [email protected]

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