This commentary originally appeared on Real Money Pro at 1:00 p.m. on April 26. Click here to learn about this dynamic market information service for active traders.
Treasury bond rates have sold off this week as a "conventional" outcome in the French election eased some fears. I've been bearish on Treasuries the last couple of weeks, in part because I thought the reasons for the rally were transitory. With one of those transitory events out of the way, where does that leave us?
Was It All About Le Pen?
Sunday's first round of the French presidential election was really not about Marine Le Pen per se, but Socialist candidate Jean-Luc Mélenchon. We knew Le Pen was likely to get to the runoff, the market just wanted to make sure a mainstream candidate was going to be her opponent. Had Mélenchon made the second round, which was a low but reasonable possibility based on polling, the markets would have had two unacceptable candidates to deal with. Both put the euro project at risk.
Emmanuel Macron is Le Pen's opponent, and he is about 20 points ahead in current polling. That is a far greater margin than either the Remain campaign in the Brexit vote or Hillary Clinton ever enjoyed, especially with under two weeks before the election.
There Are Other Reasons Why Rates Have Fallen
I have mentioned four big reasons why the 10-year Treasury rate fell from the 2.6's to the 2.2's.
- Hope for fiscal boost waning: This knocked some of the zeal out of Treasury shorts, and might be a good reason why we aren't at 2.6%, but can't explain 2.2%.
- Weak payrolls: As I have written a few times, I think the meager 98,000 payroll gain was an aberration. Fundamentally, we should be in the high 100,000s or low 200,000s.
- Falling European sovereign yields: The German 10-year fell all the way to 15 basis points, mostly on French election worries, and has bounced to 0.36%. But the economic fundamentals are strengthening at least enough to support mildly higher rates.
- Geopolitical worries: Syria/North Korea isn't going to have a lasting effect on yields unless things escalate quite a bit from here. Could happen, but we'd have to call it a tail risk.
All of these items are either transitory or aren't enough to explain rates down in the 2.3's.
The New Support Is Probably 2.32%
The old resistance has become the new support. If you shorted at 2.22% and set this as your target, then stick to your discipline. But we are seeing positive momentum out of European fundamentals. U.S. rates have been highly correlated with core European rates for quite a while. Plus, I still think the sentiment is generally bearish on rates. So it won't take much for people to reset shorts. The bet is we'll explore higher rates than this, maybe something like 124.375 on the 10-year future, which corresponds to around 2.42% on the actual 10-year.
Big Week Next Week
If you are looking for a bearish catalyst, you'll get a few swings at it next week. The Fed meets Tuesday and Wednesday. It would be pretty shocking if the Fed actually hiked, but it could telegraph a June hike. Right now the market is projecting around 70% odds of a June hike, so it might take an overt statement to move the market a ton. But I still feel strongly that the Fed is resolute on normalization. There is more room for this upcoming statement to be seen as hawkish rather than dovish.
That being said, Friday's payroll report will probably be more impactful. I fully expect March's weakness in nonfarms will look like an aberration. I don't know if April's report will fully offset March's weakness. It is entirely possible that February's report was abnormally strong. But I think when we look back two or three months from now, we will probably average close to 200,000 per month in gains. That will be plenty to keep the Fed on track to normalize policy.
With all that in mind, there remains only so much room for rates to fall. I'd be on mildly higher rates in the near term.