US rates to remain on the merry-go-round

Markets

US equities were a bit softer Monday, S&P down 0.3% and US10yr yields up 7bps to 3.2% on the back of robust data. A healthy beat on durable goods orders, rising 0.7%mom in May, consensus looked for a 0.1%mom gain. While Pending home sales were also better, up 0.7%mom in May, consensus looked for a 4%mom decline.

Just as weaker-than-expected survey data have caused investors to reassess their expectations for an economically scorching pace of monetary policy tightening, hot data and higher oil prices have triggered second thoughts about those reappraisals, leading to a directionless day for the S&P 500 as US rates remain on the Merry-Go-Round.

We think hot prints can provide room for repricing higher in front meetings, with the risk now that recession concerns are more on people's minds. Hence, there is less of an open playing field for central banks to sprint to the finish line of their respective end-of-year terminal rates without raising eyebrows.

There were two-tailed UST auctions overnight. The 2y tailed 0.7bp and 5y tailed 4.5bp as US durations continued to selloff, and the rally G10 FX has pulled back in reaction to higher US yields and lower equities.

While folks are respecting month-end rebalancing flows, they are still paying homage to the Fed thinking exogenous factors are still increasingly driving Fed policy. By focusing on headline over core, US monetary policy is especially susceptible to exogenous determinants and energy prices. That observation implies higher volatility around the rates and stock markets.

It would be simpler if risk markets concentrated on data rather than bond markets. Rates markets are a revolving carousel of confusion, and we think the signals from bonds are being misinterpreted. While equities gain when yields fall and sell off when yields rise. But of late, yields have dropped because of recession risk; that is a risk-off, not a buy signal. 

Indeed, in the face of persistent inflationary pressures, surely the equity market would prefer to face economic growth rather than stagflation. Further, the rates market may have revised its Fed view, but with rates still seen at 3.00% in late 2024/into 2025, the policy will still be net restrictive (versus Fed estimates of r* at 2.5%) while 2023 Fed funds pricing has limited downside.

Oil

WTI closed at the highest level since June as fundamentals overtake recession fears for now, as spot traders veer back to supply tightness with traders flying blind without the EIA inventory data due to a hardware malfunction at sources. Hence it makes sense to default back to what we know and not speculate on what we do not know.

Despite political Pollyanna in the oil patch, the structural shortages remain unresolved. More barrels must come to markets for oil prices to move meaningfully and steadily lower, not the price cap economics.