Fixed Income Dashboard

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What’s Behind the Recent Rates Rout?
How things can change in one quarter… Just as quickly as we priced in a recession following March’s bank turmoil, we priced it back out and then some. As the narrative pendulum swings aggressively, rather than simply pricing out a recession the market overshoots and reprices to higher forever as it extrapolates the Q3 growth surge into a durably higher nominal growth environment.

A litany of justifications have emerged to rationalize the bear steepener that has seen the 30-year US Treasury briefly breach 5%, with the 10-year nearly touching 4.9%. While market participants seek a smoking gun, it appears instead of a large seller of duration, the issue is the lack of a marginal buyer. Recessionistas have been forced to capitulate. Soft landing bulls have already shot their bullet as many eyed the 4.00%–4.25% level to lean back into duration. Speculative strategies continue pressing shorts and riding momentum. The Fed’s quantitative tightening is passively allowing maturities to run off, removing an incremental source of price-insensitive demand. Also, commercial banks have been modest net sellers increasing lending and shifting towards front-end yields.

While we may never know the precise reasons behind this historic selloff, one thing is clear – the market is reflecting a higher nominal growth world that may not come to fruition.

US Treasury Yield Curve (As of 9/29/23)
Source: Natixis Investment Managers Solutions, Bloomberg

Inflation Downshifts as Growth Moderates
What’s perhaps most fascinating about the recent rates rout is it comes amid an increasingly optimistic inflation outlook. We have seen a marked downshift in the pace of recent inflation prints, and even downside surprises haven’t sufficiently short-circuited the negative feedback loop at play in the rates complex. Elevated year-over-year inflation prints are now a relic of the past as we’ve settled into an annualized pace at or below 2% when we exclude the lagged effects of shelter, with a massive pipeline of disinflation yet to hit.

While the market continues to fear that strong growth is inconsistent with fading inflation, further supply-side normalization, easing labor market tightness, and improving productivity mute the inflationary impulses of strong growth. Robust real growth is not inconsistent with cooling inflation and slowly slowing nominal growth.

Trends in Inflation (6/30/11 to 9/30/23)
Source: Natixis Investment Managers Solutions, FactSet.