- U.S. benchmark Treasury yields fluctuated and fell on Thursday, mainly driven by news of the U.S. and Iran reaching a memorandum of understanding and extending the ceasefire deadline by 60 days. This move is seen by the market as a significant development in ending the three-month-long geopolitical conflict in the Middle East.
- Meanwhile, recent U.S. macroeconomic data has been mixed, with April's new home sales growth slowing and capital expenditure showing weakness. While inflation remains stable, signs of slowing economic growth have somewhat eased the tightening pressure on the Federal Reserve (Fed).
- Despite a temporary easing of geopolitical tensions, there is still a divergence among Fed officials regarding the outlook for monetary policy. Some officials emphasize that if inflation does not decline as expected, further tightening may be necessary, which also limits overall bond market volatility.
Partial Easing of Geopolitical Tensions Triggers Decline in U.S. Treasury Yields
The latest report shows the U.S. 10-year Treasury yield at 4.457%, down 2.4 basis points; the 30-year Treasury yield also fell 2.4 basis points to 4.987%. Despite a military skirmish between the U.S. and Iran near the Strait of Hormuz earlier on Thursday, including U.S. strikes on alleged Iranian drones and Iran's subsequent attack on a U.S. Air Force base in Kuwait, the ceasefire extension memorandum quickly calmed market sentiment. Investors' demand for safe-haven assets was somewhat absorbed, thereby lowering long-term Treasury yields. Currently, the spread between the 2-year and 10-year U.S. Treasury yields, a key indicator of economic expectations, remains at a positive 43.0 basis points.
Mixed Economic Data Intensifies Potential Stagflation Concerns
Behind the decline in Treasury yields, the latest U.S. economic indicators present a complex picture. The data shows slowing economic growth accompanied by weak capital expenditure, while inflation remains stable. Peter Cardillo, Chief Market Economist at Spartan Capital Securities, pointed out that the current data reveals the economy is facing stagflation challenges, which is a major issue for policymakers. Additionally, the upcoming April trade balance data from the U.S. Department of Commerce will be the next important reference for the market to assess the overall economic trend in the second quarter.
Fed Officials Divided on Interest Rate Outlook
Regarding policy outlook, there is a clear division among Fed officials. St. Louis Federal Reserve Bank President James Bullard stated at an economic conference in Iceland that if inflation does not return to a slowing trend within the next six months, the Fed may actually need to raise policy rates. In contrast, New York Federal Reserve Bank President John Williams believes that given the current outlook, the existing monetary policy is appropriately positioned. Although he expects inflation to remain high in the short term, related pressures are expected to ease later this year. If core inflation indicators fluctuate in the future, the market's pricing of the Fed's rate path may face reassessment.
Robust Demand in Bond Auctions Provides Technical Support
In the primary Treasury market, the U.S. Treasury's auction of $44 billion in seven-year Treasury notes in the afternoon received slightly above-average demand, with a bid-to-cover ratio of 2.52 times. The 2-year U.S. Treasury yield, which typically fluctuates in sync with interest rate expectations, fell slightly by 0.8 basis points to 4.025%. In terms of inflation expectations, the breakeven yields for 5-year and 10-year U.S. Treasury Inflation-Protected Securities (TIPS) were reported at 2.554% and 2.406%, respectively, indicating that the market expects the average annual inflation rate over the next decade to remain around 2.4%. The steady absorption in the primary market has provided some price support for medium- to long-term U.S. Treasuries.
