Do US Rates Have it Right?

From the Desk of Ian Culley @Ianculley

Whether you’re looking across the curve or around the world, interest rates continue to rise.

Benchmark rates in Germany, France, Spain, and Portugal hit fresh multi-year highs last week. Interestingly, the US 10-year yield did not. And neither did the two-, 5-, or 30-year yields.

I’m not claiming US yields have put in a lower high. It’s far too early to assume that. A downside resolution below last month’s pivot lows needs to materialize before making that claim.

Nevertheless, the lack of confirmation from US interest rates is intriguing, especially as European yields turn lower this week.

Check out the triple-pane chart of Developed European 10-year yields (Germany, France, and Spain):

All three broke above their respective Oct. highs, finishing 2022 on a high note. But those breakouts were short-lived as yields are sliding lower this week. 

The lackluster moves from European yields suggest potential failed breakouts. These failed moves could turn out to be nothing more than false starts, of course. But I can’t ignore the fact that the US 10-year yield remains well off its Oct. highs. The lack of confirmation from US rates could prove prescient.

For the past year and a half, I have looked to developed market yields outside the US for insight into the direction of domestic interest rates. It has proven invaluable on multiple occasions. 

The rationale (based on rising rates worldwide) works both ways. It follows that developed market yields should confirm one another as long as the rising rate remains intact. And when they don’t, it raises an eyebrow or two.

Here’s a daily chart of the US 10-year yield highlighting the divergence:

Sure, the underlying trend moves up and to the right. I’m not arguing that it isn’t. 

Just consider, perhaps, US rates have it right? And developed yields worldwide head lower from here.

I’d have to witness a breakdown in the US 10-year below 3.40% before taking that stance from an intermediate time frame.

If it does, our recent bond setups likely fire buy signals again, and long-duration assets such as communication and tech stocks will probably enjoy a reprieve from selling pressure.

It’s tough to say where rates are headed based on the divergence between US and European yields and a sideways near-term trend. The market is a mess.

No matter what direction rates trend (up, down, or sideways), it will carry broad intermarket implications, impacting investors worldwide.

Stay tuned!

Countdown to FOMC

Following the recent double-hike, the market is pricing in a single-hike at the February meeting.

Here are the target rate probabilities based on fed funds futures:

Click the table to enlarge the view.

This data is from the CME FedWatch Tool as of January 5, 2023.

Thanks for reading. And please let us know what you think.

As always, be sure to download this week’s Bond Report!