USD Rates: UST trading closer to fundamentals after a dose of optimism

Modest receive bias
Group Research, Eugene Leow19 May 2023
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    US Treasury yields are pushing the top of their respective trading ranges (2Y and 10Y at 4.25% and 3.65% respectively). Since the regional banking sector stresses hit in March, yields have traded depressed versus fundamentals. It was not until the last week when it became clear that banking crisis risks have meaningfully receded for now. A considerable recession premium in UST across all tenors is now being unwound. Firm jobless claims figures, optimism in debt ceiling talks and some hawkish Fed speak have pushed yields meaningfully higher. 

    In the front of the curve, markets are now pricing in a 32% chance of another 25bps hike in June. Aggressive rate cut bets out to end-2024 are also being pared. This was in line with what we had written last week (see here). Rate cut bets might be further faded but we suspect that short-term upside for 2Y yields might be capped at 4.30% (our forecast for 2Q). Meanwhile, 10Y yields are also rising as inflation breakevens ground higher. 10Y breakevens are now at 2.24%, up from barely 2.1% a week ago. Under more benign circumstances, we think 10Y breakevens should be in the 2.3 to 2.4% area, pointing to slightly further upside to 10Y yields. 

    The interplay of rising stocks and rising yields is positive for sentiment. But when overlaid with a stronger USD and understanding that too high yields might lead to another short circuit in the markets, we are wary of extrapolating these dynamics too far. From here on we are leaning in with a modest receive bias. 

    Eugene Leow

    Senior Rates Strategist - G3 & Asia
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