This analysis is by Bloomberg Intelligence Analyst Will Hoffman. It appeared first on the Bloomberg Terminal.
The 10-year Treasury may sell off to a yield of 4.24%, the next important technical level. The continued market (and our) reassessment of when the Federal Reserve will stop hiking interest rates — and eventually cut — will be informed by the February US employment, retail sales and consumer price data releases. These are by far the largest market movers.
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Data prior to Fed meeting has added meaning
The strength of January’s economic reports add importance to the February data the markets and Federal Reserve will get prior to the March 21-22 FOMC meeting. Next week’s payrolls report will be front and center. Though the market tends to react strongly to beats and misses to this data, some of the details, such as service-sector wages, will be of keen interest to us as we assess the strength of future inflation readings. Retail sales and CPI will also be released prior to the meeting and may gain more influence on market moves if they surprise either way.
Markets and the Fed are always influenced by the data. Yet given the upside surprises on economic activity, the central bank may feel compelled to mention its reaction function, explaining more explicitly under what circumstances it would adjust upcoming policy.
Forward indicators head fake or turn?
For our Treasury yield outlook, we weren’t too concerned about the upside surprise to January’s inflation data. However, the other data — particularly the surprisingly strong ISM Manufacturing Prices Paid and New Orders surveys cause us to re-evaluate our views. Prior to the recent data, leading indicators were still suggesting a significant economic slowdown and lower prices were likely in the future. A single month’s jump in the ISM data isn’t enough for us to completely change our view, but the strength does risk a more hawkish Fed — meaning the recent move in rates markets is reasonable.
This is how tactics and strategy diverge. Tactically, the market is leaning bearish and the data remain robust. The question is long term, will the data remain on an uptrend, or will it falter later, causing a rates rally?
Ten-year yield targeting 4.24% on robust data
The strong data continues to be an impetus for Treasury yields to sell off, with the 10-year now clearly targeting 4.24%, the November yield peak. A break of this level could see a re-test of the cycle high of 4.34% set last October. Momentum indicators are close to oversold territory, which may arrest any major upward yield move prior to the February employment report.
If the 4.24% level holds, 4.01% becomes the new support, followed by a resistance area of 3.88-3.9%. Below 3.88% would suggest a return to the November to late February range of 3.32-3.9%.
Two-year treasury yield target over 5%
Technically, the front end of the yield curve is in oversold territory on several momentum indicators such as the relative strength index (RSI). However, in the last few years, the RSI wasn’t a particularly good indicator of market turns — especially when the Federal Reserve was increasing interest rates, as in 2018. With a break of the old cycle yield high of 4.8%, the two-year note yield now targets 5.13%, the 2007 yield high, followed by the 2006 yield high of 5.28%.
The Fed hiking rates above 5% is nearly a given since recent data. The two questions for the front end of the coupon curve are how high above 5% does the Fed go, and how long does it stay there. One reason for the recent selloff has been the pricing of a slower and later path of rate cuts — which we think remains the key for short-term yields.
Bloomberg
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