The (very) long end of the US yield curve recently hit multi-annual highs

Markets

Oil prices traded volatile yesterday between $88/b and $90/b. The Iranian headline roulette kept spinning conflicting messages. The US upping compensation demands from Iran caused a first spike higher before, comments of the Pakistan defense minister caused a turnaround. He said that the US and Iran are close to some sort of arrangement over Hormuz. “Things are shaping up in favor of peace”. Earlier, Al Jazeera also reported on advanced talks between Oman and Iran about reopening some maritime shipping. Finally, two incidents (Houthi attacks in Bab el-Mandeb and US missiles towards ship attempting to breach economic blockade) pushed Brent back to $90/b.

Core bond yields eventually mimicked these gyrations, but eventually closed off the intraday highs in the run-up to today’s July US CPI inflation numbers. Daily changes in the US ranged between -2 and -3 bps with Treasuries slightly outperforming German Bunds. Last month, US CPI surprised to the downside of expectations and was interpreted both as a sign of weaker demand and as a beneficial supply shock. The main surprises came from shelter and the supercore measure (core services excluding housing). This was partly driven by a one-off decline in hotel prices following the World Cup and partly by an unusually weak reading in vehicle insurance prices. For both the supercore and shelter components, we expect positive month-on-month growth to resume. Price expectations in the services sector increased in July, as did rents, resulting in our nowcasts of 2% Y/Y and 3.3% Y/Y respectively for these components. For used car prices, we remain negative at -2.5% Y/Y in July, following a decline in the Manheim Used Vehicle Value Index. High-frequency indicators across the food production chain remain very benign, and we therefore assume modest growth of 3.1% Y/Y. In the energy sector, despite a slight month-on-month decline, the annual rate is expected to remain around 14.5% Y/Y. Overall, we nowcast US headline CPI at 3.3% Y/Y for July and core CPI at 2.4% Y/Y. Both figures are 0.1 ppt below the Cleveland Fed's nowcasts and below median market consensus. Such outcome could benefit US Treasuries, probably in bull steepening fashion, and could weigh on the US dollar. September Fed rate hike bets hover around 50% with room for repositioning if data warrant to. In July, three FOMC members dissented in favour of a rate hike with Washington-based governors Cook, Jefferson and Waller all inclined to possibly back a 25 bps move higher in September if inflation doesn’t show sufficient signs of cooling. August CPI numbers will also be released ahead of the next Fed meeting.

The (very) long end of the US yield curve recently hit multi-annual highs, but this was the result of higher real rates rather than inflation risk premia. This could either suggest confidence in monetary policy to prevent the current oil shock from having a permanent impact or a return to worrying over underlying fiscal developments. In the US, we currently have the rather unusual set-up in which the 10-yr real rate exceeds the inflation risk premium. In Germany, the 10-yr real yield is currently testing 1%, its highest level since 2011. Apart from CPI figures, it’s worth paying attention to the US Treasury’s $42bn 10-yr Note auction today to test investor appetite after for long-term US debt. Tomorrow, the Treasury completes its mid-month refinancing operation with a 30-yr Bond auction.

News and views

A container ship paid a near-record $4mn in the Panama Canal Authority’s daily auction process to skip the regular queue. The Hormuz closure triggered a global rerouting of container traffic which is now running in its own problems, pushing traffic costs and delivery times higher. Average auction prices for transit slots on the Canal more than doubled as the wait time for transit rises to 10 days. Earlier, the Panama Canal Authority reduced the maximum authorized draft due to falling Gatun Lake water levels. Maintenance outages that will last until September are adding to the bottleneck. Separately, several German states have suspended a Sunday driving ban for lorries. They did so as Europe’s heat wave pushed Rhine water levels to their lowest since record began in 1880. The Kaub chokepoint, the shallowest point and critical for traffic between Rotterdam and southern Germany, has fallen to just 21 centimeters of clearance. Since last week, vessels are limited to 200 tons, only 10% of a standard barge’s normal capacity. Germany’s association of inland shipping (BDB) has warned that water levels could soon be so low that shipping along the full length of the Rhine becomes impossible.

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