Equities rally on US data, shifting Fed expectations and yields
Stocks Hit Record Highs
Equities Rally on US Data, Shifting Fed Expectations, and Global Sovereign Flows
The financial markets are currently navigating a nuanced landscape marked by a rally in equities, evolving expectations around Federal Reserve policy, and significant sovereign movements—particularly China’s recent trimming of US Treasury holdings. These interconnected developments are shaping bond yields, investor sentiment, and geopolitical risk perceptions, creating a scenario where optimism is cautiously balanced against external uncertainties.
Recent US Economic Data Reinforces a More Dovish Outlook
Over the past week, a series of key economic indicators have bolstered the narrative that the US economy is moderating:
- Consumer Price Index (CPI) for January: Rose by 2.4%, marginally below market expectations, signaling a deceleration in inflation. This suggests inflationary pressures are easing and approaching a sustainable downtrend, alleviating some of the urgency for aggressive rate hikes.
- Employment Data Revisions: New updates indicate slower job creation, pointing to an economy that is stabilizing rather than overheating. This diminishes fears of an imminent recession and supports a cautious approach from the Federal Reserve.
- Retail Sales and Consumer Confidence: Trends show demand softening, with consumer sentiment slipping slightly. These signals imply that consumer demand is cooling, which could pave the way for a pause or a slower pace of future rate increases.
Implication: These data points have shifted market expectations toward a near-term pause or even potential easing. As a result:
- Front-end Treasury yields have declined, reflecting reduced expectations for immediate rate hikes.
- The yield curve has steepened further, driven by supply-side factors, including increased Treasury issuance and international sovereign movements, alongside the evolving rate outlook.
Market strategists, including ING’s Benjamin Schroeder and Michiel Tukker, highlight that supply concerns and front-end rate movements are key drivers of the yield curve's steepening, adding complexity to growth and inflation forecasts.
International Sovereign Movements and Their Market Impact
A notable recent development is China’s decision to reduce its holdings of US Treasury bonds. This move has several important implications:
- It could increase US Treasury issuance or lead to outright sales, exerting upward pressure on yields and heightening bond market volatility.
- China's reserve trimming appears to be part of a broader strategy to diversify reserves, amid geopolitical tensions and shifting economic priorities.
This trend aligns with forecasts such as those from a Reuters poll, which projects long-dated US Treasury yields could rise later in 2026 due to ongoing supply concerns and persistent inflation expectations. Supporting this view, longer-term yields have edged higher, reflecting market anticipation of increased issuance and inflation resilience.
Additionally, US Treasuries experienced notable sell-offs, with yields rising as concerns about economic resilience and inflation persisted. While these sell-offs temporarily tempered recent equity gains, they underscored the delicate balance of current market sentiment and the potential for increased volatility.
New Developments: Fed Signals and Market Probabilities
Dovish Fed Commentary and Regional Signals
Federal Reserve officials have recently reinforced a more dovish stance:
- Fed President Austan Goolsbee emphasized that rate cuts are unlikely in the immediate future, but could be appropriate if inflation continues to decline. He remarked:
"While the data supports a pause, we are not yet at a point where rate cuts are justified. However, if inflation continues to decline and economic conditions align, several cuts could be appropriate in 2026."
- Fed Governor Patrick Logan echoed this sentiment, stating that interest rates are 'likely to remain on hold for quite some time.'
- Supporting these views, Boston Fed’s Collins indicated that interest rates are expected to stay steady in the near term, underscoring a data-dependent but cautious approach.
Market Expectations and Probabilities
The CME FedWatch Tool now indicates a 60-70% probability that the federal funds rate will remain near 4% in the near future. However, upside risks—such as unexpectedly resilient economic data or sticky inflation—could push yields toward 4.25-4.50%.
Conversely, downside risks—like further inflation moderation or economic softening—may slightly lower yields below 4%. Notably, the Fed’s preferred inflation metric, the PCE Price Index, showed accelerating inflation in December, complicating the easing narrative and emphasizing the importance of upcoming data releases.
Real Interest Rates and External Risks
Data from the Federal Reserve Bank of Cleveland points to rising real interest rates (REAINTRATREARAT1YE), as inflation expectations moderate, exerting downward pressure on equities and influencing long-term yields.
Meanwhile, market sentiment remains sensitive to geopolitical tensions, tariffs, and risk re-pricing. The 10-year Treasury yield increased by 3 basis points to approximately 4.08%, reflecting ongoing reassessment of external risks and supply-side pressures.
The $14 Trillion Rollover Challenge and External Geopolitical Risks
A critical long-term concern is the $14 trillion US Treasury debt rollover scheduled for 2026. Analysts warn this could be a “break point” for the US economy:
- An in-depth analysis titled "The $14 Trillion Rollover Crisis: Why 2026 Will Break the U.S. Economy" suggests that massive debt maturities could lead to higher yields and increased market volatility if investor sentiment shifts or if the US faces difficulty issuing new debt at favorable rates.
- This rollover risk is amplified by geopolitical tensions, including China’s reduction of US Treasuries and broader trade uncertainties, which could exacerbate market volatility and pressure long-term yields upward.
Recent legal developments, such as the Supreme Court’s decision to strike down tariffs imposed during the Trump administration, temporarily boosted risk appetite. Nonetheless, the debt rollover challenge remains a pivotal concern heading into 2026.
Latest Market Movements and Data Highlights
Treasury Yields and Market Dynamics
- The 2-year Treasury yield recently rose to 3.459%, reflecting ongoing expectations of policy stability and near-term rate adjustments.
- Treasury yields just fell by the fastest rate in 5 months, indicating short-term market adjustments amid conflicting signals.
- The 10-year Treasury yield remains around 4.08%, with upside risks driven by international supply concerns, geopolitical tensions, and inflation expectations.
Market Sentiment and Probabilities
- The CME FedWatch suggests a 60-70% chance that rates will stay near 4% in the near term, but with potential for upward movement if inflation surprises persist.
- The short-term market moves are mixed: while the 2-year yield has shown some upward movement, recent data indicates a sharp fall in yields over the past few months, reflecting investor caution and shifting expectations.
The Yield Curve: Signaling Caution or Confidence?
The yield curve’s recent steepening—with the spread between 2-year and 10-year yields widening—has sparked ongoing debate:
- A steepening curve often signals expectations of slowing growth or a potential recession.
- However, in this environment, the steepening appears primarily driven by supply concerns and inflation expectations, rather than a clear recession outlook.
- Market analysis, such as Blain’s Morning Porridge, questions what the yield curve is truly signaling, suggesting that external supply pressures may distort its predictive power.
A recent educational resource, "Yield Curve Explained and What It Does Not Predict," emphasizes that not all yield curve steepening indicates an impending recession; external factors like Treasury supply and geopolitical risks heavily influence its shape.
Actionable Outlook and Policy Implications
Investors should keep a close watch on:
- Upcoming inflation reports (CPI, PCE), which will clarify inflation trends.
- Employment data to gauge economic resilience.
- Treasury issuance schedules, especially with China’s recent reserve trimming.
- Geopolitical developments, including US-China relations and trade policies.
- Federal Reserve speeches, particularly from Goolsbee, Collins, Logan, and others, to better understand future policy directions.
These indicators will be critical in determining whether yields stabilize, move higher, or if external shocks trigger renewed volatility.
Current Status and Future Outlook
The US bond and equity markets are in a phase of cautious adjustment. Equities benefit from softer US data and expectations of a less aggressive Fed, while long-term yields hover around 4% amid supply concerns, inflation expectations, and geopolitical risks.
Outlook Summary:
- The US economy appears to be cooling, decreasing recession fears and supporting equity gains.
- The yield curve’s steepening is mainly driven by supply concerns and inflation expectations, not necessarily signaling recession.
- External risks—notably China’s reduction of Treasuries and the $14 trillion debt rollover—pose significant risks that could trigger increased volatility.
- The Fed’s data-dependent stance suggests rates may remain steady through mid-2026, with potential for easing if inflation continues to decline and external risks are managed.
Investors should remain vigilant, monitoring inflation data, geopolitical developments, and Fed communications as these will be key in shaping market trajectories in the coming months.
Additional Market Movement: Treasury Yields Fall as Investors Await More Data
Recently, U.S. Treasury yields experienced a notable decline as investors paused to await further economic data. Specifically:
Title: Treasury yields fall as investors await more economic data
Content: U.S. Treasury yields fell on Thursday as investors awaited a wholesale inflation reading and weighed the state of the U.S. economy. The slowdown in short-term yields reflects cautious positioning ahead of upcoming CPI and PCE reports, which are expected to clarify whether inflation is on a sustained downward path. This pause in yields underscores market uncertainty about the trajectory of policy and growth, with investors balancing the risks of persistent inflation against signs of cooling activity.
This recent shift highlights how markets are becoming more data-dependent and cautious amid mixed signals.
Implications
The current environment suggests a delicate balance:
- Equities are benefiting from softer US data and expectations of a less aggressive Fed.
- Long-term yields remain elevated around 4%, influenced by supply concerns, external geopolitical risks, and inflation expectations.
- External factors, especially China’s sovereign reserve adjustments and the looming $14 trillion debt rollover, are critical risks that could influence market stability and yields.
Strategic positioning, emphasizing flexibility and close monitoring of economic indicators, geopolitical developments, and Fed communications, will be essential for investors in the months ahead.