The Rout In Two-Year Treasuries May Be Just Getting Started

Authored by Ven Ram, Bloomberg cross-asset strategist,

Back in October, we contended that Treasury two-year yields would surge past 5%.

For a time after after that - especially from November through January - it seemed the market winds had changed direction.

But after Fed Chair Jerome Powell vowed to re-accelerate the pace of tightening, the bearish mood was in full display, sending the two-year Treasury yield past 5%.

It wasn’t, therefore, any surprise to see stocks slump, the dollar flex its muscles and gold tumble.

But the most important reaction was the surge in US real rates, which has key implications for pretty much every asset.

Still, this movie may have some way to go (h/t to Daniel Curtis for chart).

Here’s why: the tell-tale three-month/10-year Treasury curve has been in a consistent inversion since November, and typically, recessions have followed between 11 and 14 months.

That would suggest that any inflection point in the US economy may be unlikely before October at the earliest - meaning the Fed may be raising rates all through the summer. That may mean that a 6% terminal rate is no longer just a tail risk but a real prospect.

Not that it’s all going to be a one-way street as there are bound to be potholes along the way.

We got the ADP payrolls data earlier today (stronger than expected), JOLTS (stronger than expected), and the non-farm payrolls print later this week, which will confirm whether January’s breakneck expansion was a blip or a trend.

There used to be a time when the outcome of non-farm payrolls had some meaningful correlation - at least from a classic statistical standpoint - with the ADP data, but in the post-pandemic world the explanatory power of the latter has almost completely evaporated.

However, the takeaway being that today's upside ADP and JOLTS prints confirm the market’s worst fears on the Fed trajectory, with traders still hanging onto their hats until we have the non-farm payrolls number.

[ZH: As an aside, Eurodollar options traders have a number of bets out there for rates being 6% or above by September...]

Do we think the equity market can handle that?