This week and next week are two of the most affected by summertime trading conditions (lower volume, lighter liquidity, seemingly random directional motivations).  Rates are also starting out at the highest levels of the year despite a friendly CPI reading last week, so maybe it's a good time to ask what rates even care about these days.  After all, it was supposed to be inflation, yet here we are.  

There are a few key themes in play right now that go beyond inflation.  Some of them circle back to inflation, however.  For instance, market chatter has quickly adopted the phrase "no landing" to replace the question of a "soft landing" for the post-covid economic growth. 

1. "No Landing"

The assumption had been that restrictive Fed policies would crimp economic output in such a way that would make it difficult for the Fed to engineer a soft landing that balanced the need to reduce inflation while attempting to avoid undue damage to the economy.  

Now, almost 2 years into the most aggressive rate hike cycle in decades, job growth numbers have only just fallen back to levels that would be considered "very strong" at any other point in the previous economic expansion.  Granted, not all the data is as upbeat, but historically low unemployment and historically strong job gains are important indications of economic resilience--at least for now.

If there's "no landing," that could imply less downward pressure on inflation.  While modest in the bigger picture, the recent uptick in fuel prices feeds that narrative.  Some analysts see the past 2 months of lower inflation readings as a temporary blip caused by a correction from an overdone spike in fuel prices.  They see the recent increases as more sustainable (especially in a "no landing" scenario) and sustainably higher energy prices would likely prevent annual inflation from making it back to 2%.

2. "Old fashioned supply/demand 101

This is actually all about supply.  The government is spending more than it did last year and taking in less revenue than it did last year.  It's also paying historically high rates of interest to service its debt.  All of the above is a recipe for increased Treasury issuance which, of course, was seen with the recent refunding announcement.  Fitch's downgrade wasn't a huge complicating factor there, but perhaps a modest one.  

3. Fed's shift from "finding" to "holding" a ceiling rate

The Fed has arguably found the ceiling for this rate hike cycle although they could technically still hike if the data re-accelerates.  One would think that would be good for rates, but it's really only been good for the yield curve.  Shorter term rates have benefited at the expense of longer term rates.  After all, short term rates don't need to move any higher if the Fed isn't seen needing to hike again.  So any adjustment in trading levels in response to the economy or the Fed's outlook (which, again, is an outlook for the "length of time spent at a ceiling") are more concentrated in the longer end of the yield curve.  This is that "bear steepening" that everyone's been talking about.

What's all this mean?

Short term rates have to fall before long term rates can fall.  Short term rates are highly dependent on the Fed's outlook for the length of time spent at the ceiling.  If the economy contracts (or moves in that direction) and if inflation remains on track for 2.0% annually, it could only take a few months for the Fed to start talking about a future rate cut.  2s would respond and 10s would see that as permission to follow, albeit a few steps behind.

The fuel price/econ growth dynamic means that those things need to moderate before we're going to see much relief in rates.  They're also precursors for the Fed's "ceiling time" thoughts.

The supply issue in Treasuries is a tough one.  Any discussion about trying to get the U.S. government to either stop spending so much money or start taking in more revenue seems like it would only exist in jest, regardless of political stripe.