The Big Picture
The month of February started well for the stock market, but it didn't end well. The month of February started poorly for the Treasury market, but it ended well -- really well!
The reason February ended the way that it did for the stock market and the Treasury market was one in the same: growth concerns.
Distracted
The 10-yr note yield will be our guide for today's discussion. It started the month at 4.55%, climbed to 4.63% by February 12, and stood at 4.22% as of this writing.
The 10-yr note yield is sensitive to inflation pressures and it responded accordingly when the preliminary University of Michigan Consumer Sentiment Index for February, released February 7, registered a big jump in year-ahead inflation expectations to 4.3% from 3.3%. That was the highest rate since November 2023 and only the fifth time in 14 years that there has been such a large one-month increase. The 10-yr note yield settled five basis points higher that day at 4.49%.
That was the same day the January employment report registered a larger-than-expected 0.5% month-over-month increase in average hourly earnings that resulted in a 4.1% year-over-year increase.
These reports followed on the heels of an ISM Manufacturing PMI that revealed an uptick in the Prices Index to 54.9% from 52.5%, reflecting an acceleration in prices from December, and an ISM Services PMI that saw the Prices Index decelerate to a still lofty 60.4% from 64.4% in December.
These reports all preceded the January Consumer Price Index on February 12 that showed total CPI bumping up to 3.0% year-over-year from 2.9% in December, and core CPI bumping up to 3.3% year-over-year from 3.2% in December.
And then, the inflation angst eased with the release of the January Producer Price Index on February 13 that featured some component breakdowns that left the market with an impression the January PCE Price Index wouldn't ring any new inflation alarm bells. That was right. The PCE Price Index moderated to 2.5% year-over-year from 2.6% in December while the core PCE Index slipped to 2.6% year-over-year from 2.9% in December.
Good news to be sure, but still not "good" relative to the Fed's 2.0% inflation target. By then, however, the Treasury market had been readily distracted by growth concerns wrapped up in disappointing retail sales in January, a slate of weak housing market data, weakening consumer confidence readings, President Trump's tariff push, and his administration's efforts to cut government spending.
A Directional Message
The stock market found itself distracted by those same factors, and as stock prices got rolled back in the latter half of February as it questioned the viability of achieving higher earnings growth projections in a slowing economy, the Treasury market rallied on some safe-haven positioning.
The gains in the Treasury market were presumably driven by some short-covering activity among participants who had been expecting lower prices (and higher yields) based on a belief that new tariffs will invite new inflation pressures that keep the inflation rate comfortably above the 2.0% target.
They could ultimately be right. Tariffs for Canada and Mexico are slated to go into effect March 4, an additional 10% tariff on imported goods from China will also take effect that day, the president has lobbed the idea of the EU soon facing a tariff in the neighborhood of 25%, and reciprocal tariffs for others are being implemented on a case-by-case basis beginning April 2.
Based on the 10-yr note's behavior, though, we'd argue that the Treasury market isn't living in fear of inflation heating up so much as it is existing on a belief that growth is primed to slow down because of the tariffs, the tariff uncertainty, government spending cuts that will include job losses for thousands of federal workers, and possibly a global trade war with the U.S. fighting on all fronts.
That is the message of the inflation-sensitive 10-yr note's direction, the flattening of the 2yr note-10-yr note spread, and the renewed inversion of the spread between the 10-yr note (yielding less) and 3-month T-bill (yielding more), which the Fed reportedly monitors closely as an economic gauge.
The prior inversion, as we all know, was a red herring for the U.S. economy, which never acquiesced to the recession monster. Will the second time be the charm? Let's hope not, yet the Atlanta Fed's GDPNow model estimate for Q1 real GDP took a negative turn in the wake of a large widening in the International Trade in Goods deficit and 0.5% decline in real personal spending reported for January.
Specifically, the model cut the Q1 real GDP growth estimate from 2.3% to -1.5%.
What It All Means
The growth concerns are running ahead of the growth promises linked to deregulation and lower tax rates. One important reason why is that the latter have not come to fruition yet in the forceful manner that they have been advertised.
They might, but the GOP-controlled Congress has a big weight on its shoulders to work out a tax plan that won't increase the deficit -- or at least creates an impression that it won't increase the deficit. Ten years is a long projection horizon when anything can happen. There is some heavy lifting still to do there in the coming months.
In the meantime, the weight of economic evidence of late, as seen via the Citi Economic Surprise Index, has not been on the side of a stronger growth outlook. That could be because economists simply got overly optimistic with their forecasts, or it could mean the economy is hitting a wall for a variety of reasons.
We will know more in time, but the direction of the 10-yr note yield suggests that there is a growth monster now that is more menacing than the inflation bogeyman.
