The bond market once again finds itself at a key juncture

10-year Treasury yields have been on the decline this week but once again, it is meeting a bit of a pause near the 4% mark. It’s familiar territory as the key level is what halted the market move back in April and also in September. The drop in yields in April did touch a low of 3.86% but the birth of the TACO trade saw a quick reversal in yields moving back up above 4% after.

So, what’s the story this time around?

The drop this week is stirred by US-China trade tensions and we’re seeing a bend but don’t break situation for now. 10-year yields flirting with the 4% mark is one to take note of for broader markets, so let’s see what the balance of scales would imply.

There’s two sides to the story now. One, being that yields have already been driven lower amid more dovish Fed expectations ever since Jackson Hole in August. Besides that, softer US economic data especially in the labour market is only helping to reaffirm the market outlook on the Fed.

And Trump threatening to escalate trade tensions with China only adds to that, with investors chasing a flight to safety i.e. bid in bonds. That is not to mention the negative connotations towards the US economy from a trade/tariffs war with China.

However, the other side of story implores that there are still risks to inflation that might not have shown up in the data yet. The Fed seems adamant to play down the impact from tariffs passthrough, arguing for it to be temporary. That being said, we all know how central banks can be wrong on matter such as this. Just think back to the whole “inflation is transitory” debate after the Covid pandemic.

So, there is definitely a risk that tariffs inflation could be more persistent and stubborn. That especially if the trade war with China escalates further and becomes more prolonged.

The thing about the two arguments above is that one is much easier to see than the other. Meanwhile, the other seems to be requiring a much longer time to even get a sense of its potential impact.

If the US labour market softens further, it just serves to reaffirm market expectations on the Fed outlook. And if not, it will help to accelerate a more dovish pricing if the data really is bad. In turn, that means a further decline in yields will be coming.

As for the inflation argument, the only thing that the naysayers can wait for is the US CPI and PCE reports each and every month. And amid a US government shutdown in October, they won’t have anything to work with this month.

I feel that the 4% mark in 10-year yields is a key line in the sand now in defining the bias on both sides of the story. If either side is to run away with it and exert their narrative on broader markets, it will be based on which side of the 4% level that yields will stray.