Inflation Signals Set Stage for Treasury Curve Steepening

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Here’s what you missed today:

Bear steepener risk grows amid deepening liquidity drain

US stocks finished the day lower, though not as much as I expected. I had mentally been ready for a 1% decline in the S&P 500, but instead, it fell by only 40 basis points. Still, if this plays out as expected over the next month, it will likely make little difference.

If you looked at the S&P Global PMI data today, the Fed should not be cutting rates. If you looked at the Philly Fed Prices Paid Index, the same conclusion applies. That Philly Fed index rose to 66.8, the highest since July 2022, when CPI was running at 9% and PPI at 11.2%. This doesn’t mean inflation is heading back to those levels, but it does suggest the rate of change in inflation is accelerating, and quickly.

Powell would be a fool tomorrow to suggest rate cuts are coming in September, or even hint at them. Based on Wednesday’s Fed minutes, to me, the odds of a September cut look slim to none. CPI swaps are clearly signalling the Fed should not be cutting rates—the 2-year CPI swap rose today to 2.94%. Cut rates now, and that pricing is likely to move much higher.

In the meantime, rates remain stuck, but at some point, something has to give. The 30-year minus 3-month spread has been frozen around 70 bps since January. If the Fed isn’t cutting and inflation is rising, how can the curve not shift? It seems absurd that it has been stuck for months at this level. From a technical perspective, the spread is either forming one of the largest cup-and-handle patterns ever or a major ascending triangle. Either way, I think the curve is set to steepen materially—and it won’t be because the 3-month rate is falling, but because the 30-year yield is rising.

If you’re looking for some excitement tonight, we get the Japan CPI report. Headline CPI is expected at 3.1% y/y, with core CPI (ex-fresh food and energy) at 3.4%. Meanwhile, the 30-year JGB closed last night at its highest yield in at least 25 years.

Meanwhile, the 10-year JGB is also on the verge of breaking through significant resistance.

-Mike

Terms by ChatGPT

Glossary

Ascending Triangle – A bullish chart pattern formed by a horizontal resistance line and a rising support line, often signaling an upward breakout.

Basis Point (bps) – A unit equal to one hundredth of a percentage point, used to describe changes in interest rates or yields.

CPI Swaps – Derivatives contracts where parties exchange fixed payments for payments linked to consumer price inflation, reflecting market expectations for future inflation.

Cup-and-Handle Pattern – A bullish technical formation resembling a “cup” followed by a small consolidation “handle,” typically suggesting a potential upward move.

Headline CPI – The consumer price index that measures inflation including all components such as food and energy.

JGB (Japanese Government Bond) – Debt securities issued by the Japanese government, considered a benchmark for Japan’s bond market.

Philly Fed Prices Paid Index – A regional survey from the Federal Reserve Bank of Philadelphia measuring prices paid by manufacturers, often viewed as an inflation indicator.

PMI (Purchasing Managers’ Index) – A survey-based economic indicator measuring business activity in manufacturing and services sectors.

PPI (Producer Price Index) – An index measuring the average change in selling prices received by domestic producers, serving as a measure of inflation at the wholesale level.

Yield Curve Spread – The difference between yields on two bonds of different maturities, commonly used to assess market expectations for growth and monetary policy.

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