In reading through market commentaries this morning, we saw a multitude of headlines highlighting the 10yr U.S. Treasury coming within decimals of 3%, with the high tick overnight registering 2.9957% according to Bloomberg. This comes as trade and geopolitical tensions appear to be fading, at least for the moment, and ahead of some key economic data set to be released over the next few trading sessions. While the headline data point comes Friday with the initial reading of Q1 GDP, more important will be inflation data, specifically the Personal Consumption Expenditure Index (PCE) that will be released on April 30 th .
GDP is expected to be 2% in Q1, down from 2.9% in Q4. However, most economists are predicting a rebound in Q2 and the second half of the year, a notion that has generally been accepted by not only market participants, but also by the Fed. Inflation however, is less certain. Core PCE, which strips out volatile components such as food and energy, is expected to register 2%, meeting the Fed’s target level. This hasn’t happened since 2012.
The ability for inflation to not only hit 2%, but sustain this level, will be key for how the market trades in the coming weeks and months as inflation is a key input into the level of long term rates (i.e. where the 10yr goes from here) and the pace at which the Fed continues to tighten monetary policy. This pace is what we are watching closely as we believe it will impact not just U.S. Treasury prices, but riskier sectors of the bond market as well, a point we discussed on our recent 1Q fixed income market call (a replay of which can be obtained upon request). So is the 3% level the make or break point for bonds? That is a difficult call, but how inflation develops will be a key clue in answering the question.