MBS Live Day Ahead: Positive/Negative Potential Outcomes; Why This Time is Different

It will come as no surprise that I feel the level of discussion about 10yr yields being at 3% is overdone at best, and misguided at worst.  Actually, it's clearly overdone, so let's talk about how it's misguided by taking a quick inventory of a few fundamentals in play the last time rates crested 3% compared to those same fundamentals now.

CORE CPI INFLATION

THEN: 1.6-2.0

NOW: 2.1

AVERAGE (6-quarter) GDP READING

THEN: 1.5-2.4

NOW: 2.6 (could be higher on Friday)

STOCK PRICES

THEN: S&P closed out 2013 around 1850

NOW: 2634 at yesterday's close

FED POLICY STANCE

THEN: Tapering announced, but reinvestments remained and rates were pinned at 0-.25

NOW: Reinvestments being tapered (more to come).  Fed target: 1.5-1.75% and more hikes foreseen

OTHER CENTRAL BANKS

THEN: Europe had not even begun its big QE plan yet

NOW: Europe's big QE plan slated for tapering after Sept 2018.  Other central banks talking about tightening.

FISCAL POLICY STANCE (ISSUANCE OUTLOOK)

THEN: cruise control.  No major developments after Fiscal Cliff (resolved Jan 2013, well before rate spike)

NOW: Tax bill creates huge Treasury issuance needs (selling more bonds to cover revenue loss).  This is certainly priced-in to current rates, but note completely.  It's also a moving target until we see what the increase in revenues looks like from any uptick in economic activity/profits/earnings/etc.

The bottom line is this: if rates managed to make it just above 3% then, they should clearly by much higher now.  They would be there already if markets didn't have doubts about how the next few years would pan out.  There's also some inherent limit to how quickly markets are willing to move relative to certain inputs.  Things like the taper tantrum and the financial crisis can cause the biggest movements.  The 2016 presidential election and the tax bill were close 2nds. 

The point is, we're likely still on a path toward higher rates--one that will only be derailed by things like full-blown trade wars and/or a bonafide bear market in stocks.  Of course the rolling-over of the economic cycle (recession) would do the trick as well, but we're not quite there yet.

So if much of the pain is priced-in, but there's some more pain left to be doled out, how high could we go?  10yr yields of 3.25% serve as a base case for many analysts.  That doesn't mean they'd be a hard and fast ceiling necessarily, but rather, that's the plateau yields would need to reach before more serious thought could be given to a correction toward lower rates that we could actually get excited about.