Rates: 10Y US fair value still pegged at 1.60%

Fair value for 10Y bond yield at 1.60%
Eugene Leow24 Sep 2021
    Photo credit: Unsplash Photo

    10Y US Treasury finally climbed above 1.40%. There was no obvious trigger and it may well be a lagged impact after the market digests the implications of a more hawkish Fed and subsequently, a more hawkish Bank of England (which hinted that rate hikes could come within the next few months). In any case, the equity markets took the more than 13bps jump in 10Y-30Y yields with no sign of strain. We would interpret this as taper being successfully communicated, and with the added clarity, risk sentiment got boosted. The market also seems to be looking past Evergrande’s woes.

    USD interest rates are now reflecting a more sanguine outlook. Since mid-2021, shocks from the Delta-variant, elevated inflation and Chinese regulatory risks have weighed on yields as the growth outlook weakens. Last night, the UST curve appears to be shaking off stagflation fears. Our rates breakdown indicate that rate hike pricing and term premium (which captures global growth sentiment) finally took meaningful legs higher. Overall, the rates assessment is closer to our view that peak Delta is already behind us and the global recovery is ongoing, China slowdown risks notwithstanding.

    With respect to fixed income strategy, pay on dips for USD rates makes sense. Our fair value assessment for 10Y yields still stands at 1.6%. Overall, we still see the pre-pandemic range of 1.5-2.0% as normal. While 1.20% was the dividing line for 10Y yields, that level of support may have shifted higher to 1.30%. On the curve, the steepening yesterday should be viewed as countertrend as the market unwound overly pessimistic views on the economy. Structurally, the curve (2Y/10Y, 5Y/30Y) should flatten as the recovery proceeds and the Fed hikes rates. We think paying 3Y to 5Y rates are a cleaner way to bet on rate hikes. As written yesterday, there is a decent chance that the first hike will get delivered by end-2022, with the initial pace of hikes at around 25bps/quarter.

    Eugene Leow

    Senior Rates Strategist - G3 & Asia

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