Treasury yields have increased 20bps in the last week
If you haven’t been keeping an eye on bond markets lately, you might be surprised to learn that 10-year Treasury yields are back to 4.1% (after hitting 3.9% a week ago) and mortgage rates are back above 7% (after falling as low as 6.6% recently).
So what’s changed?
The economy’s been surprisingly strong in all ways
In short, almost all the new data in 2024 seems to be surprisingly strong.
We can see that by looking at Citi’s Economic Surprise Index (below). The Surprise Index looks at how actual economic data performed against expectations (positive = better than expected, negative = worse than expected). As we can see, it has recently turned significantly more positive.
A long list of stronger than expected data
Some of the notable beats since mid-January include:
- Q4 real GDP grew 3.3% annualized (vs 2.0% estimate)
- 353k jobs added in January – nearly double estimates
- Initial claims for unemployment insurance neared record lows
- Manufacturing and ServicesPMIs rose more than expected
- Retail sales rose 0.6% in December (vs 0.4% estimate)
- Consumer confidence increased to 2-year high
So pretty much any way you look at the U.S. economy recently, it’s strong.
March rate cut odds fall from 90% to 20%
With inflation still falling, markets had got to the point where odds of a March rate cut were priced around 90%.
However, as each successive strong datapoint came in, markets lowered those expectations. And at the January 31 Fed meeting, Fed Chair Powell said that March rate cuts were not the “base case.” Then on Sunday, he went on 60 Minutes to reiterate that a March cut was unlikely.
Suddenly, March rate cut odds have dropped to 20%.
At the same time, markets have gone from expecting 160bps in rate cuts this year to 125bps. And as a result, we’ve seen longer-term bond yields move up too.
In short, the strong data means we’re getting back to “higher for longer” bond yields.
Could inflation change their mind?
Remember last week we talked about the “real” interest rate being unusually high, and climbing even as the Fed does nothing (because inflation keeps falling)…
We’ll get another look at inflation in one week when January CPI is out. Let’s see if it continues toward the Fed’s 2% target or if the Middle East conflict starts to impact transport costs and prices on imports start rising.
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