The curve has steepened a ton (relatively) in a short amount of time.  I think some of this was “due” – the markets had been overly complacent for a while.  I still like the thesis that the “earlier hikes are higher probability than later hikes” in a lower neutral rate environment.  I tend to favor bear flattening – but I have to acknowledge that there is a risk of bear steepening (that I would want to fade when the steepening stops).

We know that the front of the curve for some time has been underpriced to Fed hikes.  A 2016 hike is still less than 70% priced!  Surely the odds aren’t 30% that we get some horrible data in the next two months?  Call this a combination of near-term downside risks, some degree of optimal control / hysteresis, some lack of Fed credibility and the effect of QE abroad.

As for the back end of the curve, we need to ask if any of the following have changed:

(1) Do we have inflation risks that may not be addressed?  Possibly.  Chinese CPI and PPI did nudge higher (albeit from depressed levels).  Oil prices may be an issue (if you believe a bunch of broke countries will be able to agree on belt-tightening).  And I suppose there is some political risk from the US elections.  But I believe that lower inflation is more structural – better global flow and technology is going to crush pricing power on goods.  Better technology is going to put downward pricing power on services (think drone delivery, driverless cabs and automated financial services).  The main risk would have been a Trump presidency.  I know I will get a collective groan from readers at for this, but the bookies have him at 15% chance of winning.  Eh hem.

(2) Is there less QE / reinvestments?  Possibly.  The UK may not need QE, since the pound is falling like a stone.  But the flip side is, the EU may need more.  The EU is the UK’s largest trading partner (by far).  This can’t be good for EU exporters (see Marmite).  Give it a few months to kick in.  The markets are pricing in very slow Fed hikes, so they should be pricing in even slower possibility of a stop in reinvestments.

(3) Is this the return of the term premium?  I doubt it.  With all the retirees on the horizon, locking in longer term seems more valuable than going shorter term.  And global QE will make this difficult.

(4) Is there a change in the long term neutral rate?  I doubt it.  2016 GDP is still pretty low.  I suppose we would get a post-election pop, but even the constantly over-optimistic Fed thinks long term GDP is going to be 1.8% and long term inflation is going to be 2%.  This smells like very low rates for the foreseeable future.  I don’t see a change in the neutral rate any time soon.

I feel like Yellen, asking all those questions.  The difference is, I have a view: I’m not sure any of these things have changed.  The main driver seems to be that people were too bullish on global rates in QE countries.  First it was the Japanese long end to sell off, then more recently EU and UK rates.  As a result, the downward pressure on US rates has also abated.

The question becomes… weighing all of the above, where is the equilibrium?  Who knows?!?  Tens are currently at 1.80%.  The long end can be anywhere (especially in the short term), since it takes forever to converge to anything (like FF effective rates).  I’m of the opinion that the Fed will hike a “few” times after this year (all other things being equal), and the next 50 bp move after that could be either up (continued recovery) or down (recession).  I think ten year rates north of 1.80% is for people who believe in things like dot plots, or who believe inflation is not structurally lower.  But in the short term anything can happen to tens – especially if people get stopped out (see Flip notes).  We are near those “key levels” again from which we can get a breakout – let’s trade accordingly.