Oil shrugged off fears over the weekend of a wider escalation in the Middle East: Iran’s response was highly telegraphed. Bonds continued to sell off, however, despite some anticipation of a ‘safe haven’ bid. But even in the event of an escalation, Treasuries may not rally much: an intensification of the conflict in the Middle East would not be deflationary.
In any case, core inflation has been running above the Fed’s target for far too long, to justify any rate cuts. Particularly now, given higher energy and commodities prices. With the Fed unable to cut rates this year, the US 10-year Treasury yield is moving up towards 5%. The signals from three auctions last week hinted that the strong labour market, combined with above-target inflation, is reducing appetite for duration at current prices, paving the way for another leg higher in longer-duration Treasury yields.
Electrification, reshoring, and surging AI demand are all pushing industrial metals higher. As of yesterday, the GSCI industrial metals index had risen 9.1% YTD. The so-called ‘weakness’ in consumer spending at the start of the year was also overplayed. Nominal core retail sales (ex-autos & gas) in the US jumped 0.97% m/m in March, with February also revised up from 0.26% m/m to 0.48% m/m.
The speed of the selloff in the bond market may be more for a headwind for equities, than the level. With underlying nominal GDP growth running in the region of 5.5-6.0%, this should be supportive of cash flows, and profit margins showed no sign of a squeeze in Q4. The US economy can arguably handle a 10-year Treasury yield of 5%, and perhaps higher (if an appropriate term premium was priced in). However, with the prospect of any Fed rate cuts this year receding, the yen has tumbled below 154 against the dollar, adding to the global selling pressure on duration. The 2-year JGB yield has jumped to 0.28%, the highest since June 2009. This is pushing up longer-dated JGB yields too, with the 40-year JGB yield climbing to fresh high of 2.26%.
