This morning, the CPI print was inline on the core at 4.1% and slightly hotter on the headline at 3.7%. The immediate market reaction was that equity futures and bonds both lost some of their overnight bid. I will spare you the enumeration of the subcomponents because it’s tedious and it doesn’t matter. The bottom line is the trend of inflation currently is sideways to down and it is likely to decelerate further as the economy slows in Q4. This print does nothing to the Fed outlook, especially in light of all the Fed speak this week about how the long-end of the curve has done “a lot of work for them”. The Fed is likely on hold for now and for a while. The far more interesting question is: what happens at the long end of the curve from here?

Today, the outstanding economist Joe LaVorgna, from SMBC Nikko wrote a note illustrated by the chart below. In the previous nine tightening cycles, the 10-year yield was lower three months and six months following the last Fed rate hike. The chart shows how unusual versus precedent this move in the long end has been.

As we all know, the odds are stacked against the opinion that “this time may be different”, but well, a lot of stuff in this cycle has been very different. We are a year plus and over 5% into a tightening cycle and we are still at 3.5% unemployment with jobless claims that haven’t even lifted off the bottom. Nominal GDP remains robust still running north of 6% as exorbitant fiscal spending and some real-wage growth fuel demand.

The case that yields will be higher this time unlike in the past is driven by three factors that are tangibly different this time: fiscal driven demand, a potential supply/demand imbalance for longer duration Treasuries and rising long-term inflation expectations.

Over time, rates matter. Cost of capital for consumers and businesses matters. The monetary policy lags are going to be longer in this cycle, but demand is slowing and will continue to do so. While this demand resilience is keeping yields at the front of the curve elevated, the impact it may be having on the long end is fleeting.

The supply/demand debate has become the new hot topic among economists and fixed-income strategists. Suddenly, everyone is taking close note of the Treasuries QRS “Quarterly Refunding Statement”. The most recent QRS released on July 31st is seen by some strategists as triggering the sell-off in the long-end because Treasury Secretary Yellen, after several quarters of issuing almost exclusively at the short end announced that they would be selling more duration going forward, roughly 35% more duration than over the same period last year. The concern is that this rise in supply is coming at a time when foreign sovereigns are reducing their treasury assets and US banks aren’t likely to add a lot of duration risk to their asset base again soon.

Lastly, we have pounded the table on our central theme for well over a year that long-term inflation expectations should go up driven by labor demographics, the rise of industrial protectionism, the energy transition, and untenable government debt trends. The view that the several decades of falling inflation is over is becoming increasingly consensus and is finally becoming priced into inflation expectations.

So that is the state of play at the long end. Many years of precedent says bonds rally from here, but if it was that easy, we’d all be rich.

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