•A weaker tone to recent economic data and declining consensus expectations for the funds
rate at year-end make it likely that front-end yields will drift higher more slowly than we
originally expected; we revise our interest rate forecast accordingly
•Even relative to our revised expectations, frontend yields look too low; in addition, the
asymmetric risk around payrolls, an increase in bill supply from the SFP program, and seasonals
could pressure yields higher; re-enter bearish positions
•Position for a steeper Nov-16s/Feb-17s curve
Market views
Over the past week, yields generally fell, retracing the previous week’s sell-off. The rally was led by the belly and occurred despite heavy month-end supply: the market digested $8bn 30-year TIPS, $44bn 2s, $42bn 5s, and $32bn 7s for a total of $73.5bn in 10-year equivalents, a record amount even by recent standards (Chart 1). Despite this, yields were lower by 16bp, 22bp,
19bp, and 17bp in the 2-, 5-, 10-, and 30-year sectors, respectively (roll adjusted where applicable).
To an extent, this decline is a reversal of last week’s knee-jerk reaction to the discount rate hike; indeed, the expectation of retracement was a key reason we turned neutral last week. However, beyond this effect, the weakening tone of economic data continues to have an impact on Fed expectations. As Chart 2 shows, the OIS curve has flattened as the J.P. Morgan EASI index of
economic surprises has fallen into negative territory over the past month. Similarly, Blue Chip consensus forecasts for the funds rate at the end of 4Q10 have evolved downwards as well (Chart 3).
We continue to view the monetar
Global Fixed Income Markets US Treasuries
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