This article comes from the 25th Financial Street.

With the hawkish signal from the Fed's June meeting, the market also expected that Fed policy would tighten ahead of schedule, with the 2-year yield rising to 0.28 per cent, a higher 12BPs than before the meeting, while the 10-year yield remained volatile since the second quarter, reaching below 1.4 per cent after the meeting and is now around 1.357 per cent (the second-quarter average was 1.6 per cent).

Given that US economic data continue to improve and Fed policy is approaching marginal tightening, why are 10-year Treasury yields volatile under these supporting factors? When will 10-year Treasury yields pick up again?

First, the yield on US debt reflects the typical characteristics of economic recovery.

After a rapid upswing in the first quarter, US bond yields have fallen from their previous highs since the second quarter, but the biggest decline so far is still less than half of the cumulative increase in the first quarter.

For example, after hitting 1.774 per cent on March 30th, the 10-year Treasury yield rose 86BPs from its low at the start of the year to as low as 1.363 per cent on June 21, corresponding to a drop in 41BPs from its high.

For another example, the yield on five-year Treasuries hit 0.987% on April 5, up 64BPs from its low at the start of the year to a low of 0.708% on June 11, corresponding to a drop in 28BPs from its high.

According to the logic of "Treasury yield = inflation index Treasury yield (TIPS) + inflation expectation", after decomposing the upward adjustment of Treasury yield in the first quarter and the adjustment in the second quarter respectively, it is found that TIPS, which represents the prospect of economic growth, has a greater impact on the 10-year Treasury yield, while the change in the 5-year Treasury yield comes more from the change in inflation expectations, that is, the Treasury yield reflects the typical characteristics of economic recovery. Medium-term inflation expectations and long-term growth prospects.

For example, in the 86BPs with 10-year upward Treasury yields in the first quarter, inflation expectations contributed to 36BPs, while 50BPs came from TIPS;, while in the 41BPs that fell in the second quarter, inflation expectations contributed only 12BPs, while 29BPs came from TIPS.

For another example, in the 64BPs with five-year upward US bond yields in the first quarter, inflation expectations contributed 60BPs and tips contributed only 4BPs, while in the 28BPs falling back in the second quarter, inflation expectations contributed 15BPs, and 13BPs came from TIPS.

II. The yield on 10-year US Treasuries has not fully reflected the level of inflation.

The correction in US bond yields in the second quarter coincided with a rapid rise in US inflation, especially core CPI, which strips out energy and food, to record highs of this century, now rising to 3.8 per cent. According to the empirical law of core CPI and US bond yield, US bond yield is significantly low, well below the trend level.

The main reason for the low yield on 10-year Treasuries is the lag in the recovery of real yields (TIPS). From the historical experience of the change of the yield difference between US debt and TIPS (the difference between the current yield and the same period of last year), since the second quarter, the average level of TIPS yield spread has always hovered at the level of-30BPs, lagging far behind the improvement of inflation expectations.

According to the empirical law of historical data, once the actual recovery of the US economy is in line with market expectations, then TIPS will recover quickly and restore synchronism with US debt.

III. Us bond yields will return to the upward trend

The divergence between US bond yield and TIPS yield corresponds to the economic operation that while inflation is rising rapidly, the improvement of the US job market is very slow.

The US unemployment rate has largely stabilized around 6 per cent since March, but core CPI has risen sharply from 1.6 per cent to 3.8 per cent over the same period. According to the new monetary policy framework of the Fed's "average inflation target", the Fed's tolerance for inflation directly depends on the degree of repair of the US job market. If there is always a huge gap in the job market, then it is difficult for the Fed to make a significant adjustment.

Due to the obvious "asymmetry" of the exogenous impact of the epidemic on the economy, the repair of the service industry has always been fettered by the epidemic in the stage of economic recovery. So far, for example, there is still a 7.629 million gap in the US non-farm job market, of which more than 70 per cent is concentrated in areas such as leisure and hotels, government services, education and health care, and business services. the repair of jobs in these areas directly depends on the recovery of the free movement of people.

The main reason why US bond yields were out of touch with the actual inflation level in the United States in the second quarter was that the repair speed of the job market was not as fast as the market expected, but in June, the single-dose vaccination rate in the United States has exceeded 50 percent, and there is hope that "mass immunity" will eventually be achieved. at the same time, the number of new confirmed cases in a single day dropped from more than 250000 at the beginning of the year to about 12000.

As a result, several key service sectors that have been slow to repair are expected to repair faster, and corresponding US bond yields will move away from the current sideways trend and return to the upward trend driven by a rise in real yields (TIPS). The event that triggered a return to the upward trend in US bond yields, especially the real yield on US Treasuries (TIPS), is likely to be the landing of more than double-digit expected growth of US GDP in the second quarter.