US Rates Strategy: Beware of the Sirens' Song

Research evidence excerpt

US Rates Strategy: Beware of the Sirens' Song

IdeaMIn Exhibit 1 , we show how our term premia model (MSUSTP10 Index on Bloomberg)

suggests that a rise in term premium at the 10-year sector has in fact contributed to the

recent rise in 10-year nominal Treasury yields.

• Over the past 5 trading sessions, we estimate 10-year term premium rose 8bp.

In Exhibit 2 , we show how our rate expectation model (MSUSRE10 Index on Bloomberg)

suggests that a rise in rate expectations at the 10-year sector has been the predominant

driver of the rise in 10-year nominal Treasury yields since the Iran conflict began.

• By now, investors are well aware that the continued closure of the Strait of

Hormuz and the rise in crude oil prices (as well as its distillates) have catalyzed a

protracted rise in short-term US CPI inflation swaps.

But what may surprise most investors is that despite all the hand-wringing about technical

drivers of the Treasury market sell-off, the rise in rate expectations (i.e., fundamentals)

contributed an equal part to it over the past 5 trading sessions.

• As realized inflation slows – like our economists expect – it allows inflation

expectations to fall, lessening the need for investors to hedge against rate hikes.

In addition, if it were supply or fiscal sustainability concerns behind the Treasury market

sell-off, we would expect the nominal Treasury yield curve to meaningfully bear-steepen.

We would also expect the UST SOFR swap spread curve to flatten, as longer maturity/

tenor nominal Treasuries substantially underperformed their SOFR swap rate equivalents.

• As Exhibit 3 shows, the recent rise in 10y Treasury yields has not been driven by

underperformance of cash against SOFR. In fact, 10y UST SOFR swap spreads have