Yield Breakout
The remaining retail earnings—Macy’s and Dollar Tree—were surprisingly opposite; Macy’s must diversify its supply chains because of the consumer’s sensitivity to tariff inflation, reducing product sourcing from China specifically.
But Dollar Tree noted a “tariff timing” which added 20 cents to EPS because of inventory shifts by front-loading tariff-sensitive goods ahead of cost escalation.
Rather than lamenting tariffs, Dollar Tree’s earnings signal companies’ ability to extract upside from tariffs through lean inventory management and the resilience of low-end consumers, whom the company targets with a multi-price format, thereby creating maximum flexibility to pass through tariff costs without losing market share.
The jury is still out on how tariffs affect consumer prices, which ultimately determines the Fed’s rate cut path. Hence, despite political risks surrounding the fiscal outlook, markets have yet to price out rate cuts.
As a result, the yield curve displays a steepening with a “twist”: 2Y yields are down as the easing cycle is not questioned, but lower short rates drive 30Y yields higher (Figure 1).
The longer end of the yield curve continues to discount the risk of a more rapid rate-cutting cycle if non-farm payrolls turn out weak, which yesterday’s ISM manufacturing employment is implying.
Hence, long-end yields are at the cusp of a breakout to the upside going into Friday’s jobs data.
Figure 1: Yield curve twist (%)
Source: US Treasury
Yet, the credit risks are also rising, especially related to the “firing” of Fed Governor Cook. Given Trump's tweet on August 20th, she should resign immediately. The credit costs for US Treasuries have gone up. The US sovereign credit default swap (CDS) by maturity point (i.e., 2Y, 5Y, and 10Y CDS spread) has shifted higher since the announcement of the Cook firing (Figure 2).
The credit risk associated with the timing of Cook's firing suggests that long-end Treasuries are discounting a monumental shift in the FOMC towards a substantially more dovish stance that drives short-term rates too low. This, in turn, incentivizes the Treasury to continue relying on T-bill issuance to finance a swelling deficit.
By following such a deficit strategy, by financing short-term by relying on stable coins and regional banks to buy short-term Treasuries, the long-end will keep pricing in a risk premium for the eventual “maturity extension,”—i.e., the US Treasury is forced to extend the maturity of issuance, to control the deficit.
Figure 2: US Treasuries’ credit costs rising (CDS, basis points)
Source: Markitt
As such, the yield breakout is already happening in 30Y yields (see Figure 3). Since the election of 2024, yields have broken the technical wedge (higher lows, lower highs) in place since 2021-22. The upside now targets 6-6.5% (see oval) if a sustained break of 5 percent were to occur.
This is quite likely in the event of weak payrolls, which will ignite expectations for a 50bps cut in September. But this is also quite likely if payrolls are surprisingly strong, igniting expectations of growth and repricing of cuts.
Either way, factors such as tariffs, deficits, rate cuts, geopolitics, or bond supply have already led long-end yields to break out. The spot yields could match what the forward market is trading: 6 to 7% long-term rates across global markets.
Figure 3: 30Y yield has already broken out (%)
Source: US Treasury