Abundant Marketplace Liquidity and Easy Credit Availability – Bond Market Review

Friday saw a repeat for U.S. Treasuries closing out the week on a sharply lower note, yields on the 10-yr note and shorter tenors went their highest closing levels since mid-December while the long bond outperformed, keeping its yield three basis points below its highest close from last month. We saw the same last Friday with yields coming off their lowest levels of the year after the red-hot January jobs report showed headline growth of 353,000, twice as high consensus. Ten-year yields jumped 16 bps this week to an eight-week high 4.18%. This week’s 16 bps increase in MBS yields (5.65%) pushed the y-t-d yield gain to 38 bps.

This week’s underperformance in longer tenors alleviated some pressure on the 2s10s spread, expanding it by four basis points to -31 bps. Crude oil extended this week’s gain to more than $4.50, or 6.3% which rattled credit markets with the obvious inflationary implications. The U.S. Dollar Index slipped 0.1% to 104.11 but rose 0.2% for the week.

Hungry Bond Traders

The longer rates stay elevated the risk of a downturn increases. This is telling at the margin with more signs of consumer stress as higher borrowing costs and weaker hiring start to eat into household spending. With the Fed seen being close to its policy rate peak, next up is focusing on growth softening.

Understandably, aware of past Fed behavior markets are conditioned for loose conditions. They expect Fed loosening measures to reverse any meaningful tightening, hence constant flipping between end of inflation and hawkish Fed speaks trades.

Weekly Recap

Friday saw a repeat for U.S. Treasuries closing out the week on a sharply lower note, yields on the 10-yr note and shorter tenors went their highest closing levels since mid-December while the long bond outperformed, keeping its yield three basis points below its highest close from last month. We saw the same last Friday with yields coming off their lowest levels of the year after the red-hot January jobs report showed headline growth of 353,000, twice as high consensus.

Abundant marketplace liquidity and easy Credit Availability have compressed corporate risk premiums to two-year lows. Collapsing Credit default swap (CDS) “insurance” prices only intensify the speculative fervor, with strong demand for debt securities ensuring record corporate issuance. Ten-year yields jumped 16 bps this week to an eight-week high 4.18%. This week’s 16 bps increase in MBS yields (5.65%) pushed the y-t-d yield gain to 38 bps.

The Bureau of Labor Statistics released its annual update of seasonal factors, which resulted in slight changes for recent CPI reports as expected with lower energy and food prices pulling back off exorbitant levels. December CPI was revised down to 0.2% from 0.3% while Core CPI was left unrevised at 0.3%. November CPI was revised up to 0.2% from 0.1% and October CPI was revised to 0.1% from unchanged in the original reading. However, Core CPI for December, Q4, and the year remained unchanged.

The lack of true surprise in the CPI release was seen in the fed funds futures market, which shows little change in rate-cut expectations for the first half of 2024 versus yesterday, according to the CME FedWatch Tool.

  • Probability of 25 basis points rate cut to 5.00-5.25% at March FOMC meeting is 17.5% versus 19.0% yesterday.
  • Probability of 25 basis points rate cut to 5.00-5.25% at May FOMC meeting is 60.1% versus 59.9% yesterday.
  • Probability of 25 basis points rate cut to 4.75-5.00% at June FOMC meeting is 52.9% versus 55.3% yesterday.

This week’s underperformance in longer tenors alleviated some pressure on the 2s10s spread, expanding it by four basis points to -31 bps. Crude oil extended this week’s gain to more than $4.50, or 6.3% which rattled credit markets with the obvious inflationary implications. The U.S. Dollar Index slipped 0.1% to 104.11 but rose 0.2% for the week.

The U.S. Treasury completed this week’s note and bond auction offerings today with another strong auction after the U.S. Treasury’s $25 billion 30-yr bond sale which stopped through the when-issued yield by two basis points. The Fixed Interest desk rated it an A.

European Central Bank policymaker Kazaks said on Friday he is not as optimistic as the market for a rate cut in the spring while policymaker Holzmann cautioned that there is a possibility for no cuts in 2024.
Bank of England policymaker Haskel said that more evidence is needed that inflation is being reduced before cutting rates.

The Carry Trade Still Pumping Along

We have been big followers of the carry trade and its impact last yar to the stock and bond market rallies post October last year in our shared market strategies. The yen “carry trade” has inflated assets during eight years of negative rates (15 years of near zero rates). It has two factors borrowing in yen and secondly flows out of Japan, both traditional and for levered speculation. The amounts are in the trillions.

“Japanese investors purchased the largest amount of US sovereign debt on record in 2023 — attracted by high yields and expectations for the end of the Federal Reserve’s tightening cycle. The net ¥18 trillion ($121bn) of purchases runs counter to concern of the Japanese dumping Treasuries to repatriate funds back home as the central bank in Tokyo lays the ground work to raise interest rates.” February 8 – Bloomberg (Yumi Teso and Daisuke Sakai):

The loose global liquidity backdrop has been instrumental in perpetuating leveraged speculation in the U.S. and globally. The massive Japanese and Chinese finance, Fed QT and attendant liquidity pressures have been counterbalanced in many ways which caught many unawares, hence the great short squeeze. Throw on top of that loose global finance and Fed/FHLB liquidity injections after last year’s California and New York bank blow up, which we saw the past fortnight is still playing out. This forced coverage and the smarter players pushed leveraged speculation (think “basis trade”) despite higher policy rates.

Private Credit Impact

The banker pushed Private Credit also hit record levels, offsetting a pullback in boom-time bank lending.

February 8 – Bloomberg (Allison McNeely): “Apollo Global Management Inc. Chief Executive Officer Marc Rowan took a ‘victory lap’ on the firm’s record year, laying out goals to double its private credit origination business and put that asset class into retirement accounts. The firm posted record annual earnings, beating Wall Street estimates as higher interest rates powered growth at the credit-focused alternative asset manager. Originating private credit assets to sell to its Athene annuities business, other insurance companies and individual investors is crucial for the firm’s growth, Rowan said. Apollo aims to raise its annual origination of private credit to $200 billion-$250 billion in five years, up from around $100 billion, he said…”

Food for thought, what would a 2024 global yield spike do? We have multiple global flashpoints with clear inflation ramifications and risks. Stay alert to possible bifurcations, global disasters can also lead to deflation and global trade destruction.

Yield Watch

Friday/Week

  • 2-yr: +5 bps to 4.50% (+12 bps for the week)
  • 3-yr: +5 bps to 4.28% (+14 bps for the week)
  • 5-yr: +3 bps to 4.15% (+16 bps for the week)
  • 10-yr: +2 bps to 4.19% (+16 bps for the week)
  • 30-yr: +1 bp to 4.38% (+15 bps for the week)

Key Rates and Spreads

Rates

  • 10-year Treasury bonds 4.17%, up +0.14% w/w (1-yr range: 3.30-4.99) (new 15 year high 10/20/23 w/e)
  • Credit spread 1.58%, up +0.13% w/w (1-yr range: 1.36-2.42) (new 1 year low 1/19/24 w/e)
  • BAA corporate bond index 5.75%, up +0.25% w/w (1-yr range: 5.28-6.80) (14 year+ high w/w 10/20/23)
  • 30-Year conventional mortgage rate 6.98%, up +0.06% w/w (1-yr range: 6.12-8.03) (new 23 year high 10/20/23 w/e)

Yield Curve

  • 10-year minus 2-year: -0.31%, up +0.03% w/w (1-yr range: (-1.07 – -0.17) (new 40 year low)
  • 10-year minus 3-month: -1.21%, up +0.14% w/w (1-yr range: -1.89 – 0.21)
  • 2-year minus Fed funds: -0.85%, up +0.11% w/w.
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y)

Money Market Flows

  • Total money market fund assets rose $16.7bn to a record $6.018 TN.
  • Money funds were up $1.197 TN, or 24.8%, y-o-y.
  • Total Commercial Paper declined $13.0bn to $1.253 TN. CP was down $8bn, or 0.6%, over the past year.

Bond auctions this week:

Bond auctions week ahead:

Next week will bring some new supply.

  • Monday: $79 billion 13-week bills, $70 billion 26-week bills
  • Tuesday: $80 billion 42-day cash management bills,
  • Wednesday: $56 billion 17-week bills,
  • Thursday: $80 billion 4- and 8-week bills,

Source: UST Upcoming Auctions

U.S. Corporate Bond Market New Issuance Records

Abundant marketplace liquidity and easy Credit Availability have compressed corporate risk premiums to two-year lows. Collapsing Credit default swap (CDS) “insurance” prices only intensify the speculative fervor, with strong demand for debt securities ensuring record corporate issuance.

“The U.S. corporate bond market is set to break new issuance records as borrowers take advantage of lower financing costs than last year and investors, emboldened by the prospect of an economic ‘soft landing,’ pile into the asset class… Issuance of bonds by companies rated investment-grade surged above $196 billion last month, making it the busiest January on record. This record issuance may be repeated this month, with BofA Global estimating nearly $160 billion to $170 billion in just investment-grade rated bond supply, which would make it the busiest February ever. Such back-to-back record months at the start of the year are unusual even for the prolific investment grade market, which is expected to see nearly $1.3 trillion of bond issuance this year.” February 5 – Reuters (Mark Niquette)

US banks Preference Toward Maintaining Reserves Impact

There has been a continuation of US banks are showing a preference toward maintaining reserves over US$3T and in order to achieve this the banks are being forced to liquidate their Treasury holdings and hence drive yields higher. Earnings reports from JPM, WFC and C gave us further indication of this pattern.

Still treasury yields have comeback with a growing sense that the bond and stock market are oversold in the short-term and due for a bounce.

Recap: The Markets Response to The Dovish Pivot Message

  • Nasdaq100 up 3.2% gain this week pushed Nasdaq100 ytd returns to 52%.
  • Semiconductors added another 9.1% adding to be up 62.6% ytd.
  • The S&P500 ended the week with a y-t-d return of 24.9%.
  • The Goldman Sachs most short index surged 14.4% Wednesday and Thursday, trading Friday morning up almost 40% from November 13th lows.
  • The KBW Regional Bank Index (KRX) posted a two-day melt-up of 10.2%, boosting the rally from October 25th lows to 40%.
  • The Wednesday/Thursday “pivot rally” saw the small cap Russell 2000 jump 6.3%, extending the rally off October 27th lows to 22%.
  • Investment-grade CDS prices dropped another four this week to 57.5 bps, the low since January 2022.
  • High yield CDS sank 35 to 367 bps, the lowest level since April 2022.
  • Investment-grade corporate spreads to Treasuries traded Friday below 100 bps for the first time since January 2022.
  • High yield spreads narrowed to April 8, 2022, levels.
  • The iShares High Yield Corporate Bond ETF (HYG) has now returned 5.6% since the Fed’s first hike on March 16, 2022.
  • JPMorgan CDS fell this week to 44.65, the low back to November 2021.
  • Goldman Sachs CDS traded to lows since January 2022.

There is a firm belief the Central Banks have been blindly raising rates because ‘they have to’ and the consequences will be dire, furthermore that the US Administration is bumbling along with damaging decisions one after the other.

Spurred by slowing inflation and signs of a cooling growth, traders and investors have recently rushed headlong into US government debt, convinced that the Federal Reserve is done raising interest rates and will shift to cutting them by the middle of next year. That ended a six-month losing streak for Treasuries and pushed the market to a gain of 2.6% in November. It’s the biggest advance since March, when there were fears that a banking crisis would sink the economy.

2-, 10- and 30-Year Treasuries Technical Analysis via KnovaWave

Highlights – Federal Reserve

  • Federal Reserve Credit declined $24.9bn last week to $7.594 TN.
  • Fed Credit was down $1.296 TN from the June 22nd, 2022, peak.
  • Over the past 230 weeks, Fed Credit expanded $3.867 TN, or 104%.
  • Fed Credit inflated $4.783 TN, or 170%, over the past 587 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt recovered $15.4bn last week to $3.360 TN.
  • “Custody holdings” were up $28bn, or 0.8%, y-o-y.

Powell at the FOMC:

Powell: “Our strong actions have moved our policy rate well into restrictive territory, and we have been seeing the effects on economic activity and inflation… We believe that our policy rate is likely at its peak for this tightening cycle and that, if the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year.”

Chair Powell: “I’m not so worried about that. Again, we’ve had inflation come down without a slow economy and without important increases in unemployment, and there’s no reason why we should want to get in the way of that process if it’s going to continue. So, I think declining inflation – continued declines in inflation – are really the main thing we’re looking at. Of course, we want the labor market to remain strong, too. We don’t have a growth mandate. We’ve got a maximum employment mandate and a price stability mandate, and those are the two things we look at. Growth only matters to the extent it influences our achievement of those two mandates.”

Powell: “So, I guess I would just say this: executive summary would be that growth is solid to strong over the course of last year. The labor market, 3.7% unemployment indicates that the labor market is strong. We’ve had just about two years now of unemployment under 4%. That hasn’t happened in 50 years. So, it’s a good labor market. And we’ve seen inflation come down… The outlook, we do expect growth to moderate. Of course, we have expected it for some time, and it hasn’t happened. But we do expect that it will moderate as supply chain and labor market normalization runs its course.”

Powell: “In terms of growth, we’ve had strong growth. If you take a step back, we’ve had strong growth, very strong growth last year, going right into the fourth quarter. And yet, we’ve had a very strong labor market, and we’ve had inflation coming down. So, I think, whereas a year ago, we were thinking that we needed to see some softening in economic activity, that hasn’t been the case. So, I think we look at stronger growth, we don’t look at it as a problem. I think, at this point, we want to see strong growth. We want to see a strong labor market. We’re not looking for a weaker labor market. We’re looking for inflation to continue to come down, as it has been coming down for the last six months.”

Highlights – Mortgage Market (Prior Week)

  • Freddie Mac 30-year fixed mortgage rates added a basis point to 6.64% (up 48bps y-o-y).
  • Fifteen-year rates declined four bps to 5.90% (up 49bps).
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates up 21 bps to an eight-week high 7.16% (up 57bps).
Mortgage News Daily

Major Benchmark 10-year Bond markets

Highlights – European Bonds

  • Italian yields gained 15 bps to 3.97% (up 27bps y-t-d).
  • Greek 10-year yields surged 21 bps 3.51% (up 46bps).
  • Spain’s 10-year yields rose 20 bps to 3.37% (up 38bps).
  • German bund yields gained 14 bps to 2.38% (up 36bps).
  • French yields rose 15 bps to 2.90% (up 34bps).
  • The French to German 10-year bond spread widened about one to 52 bps.
  • U.K. 10-year gilt yields jumped 17 bps to 4.09% (up 55bps).

Italy’s and the UK’s 10-year bond yields are the highest in the G7 after the U.S. as markets continue to worry about the extent of interest rate hikes that will be needed to bring inflation back under control.

Highlights – Asian Bonds

  • Japanese 10-year “JGB” yields gained five bps to 0.73% (up 11bps y-t-d).

Key US Bond Auction Highlights 2024

With all the redirection of blame at the Fed about inflation one has to understand it is a global phenomenon outside the Fed’s Control. With the war drums louder than ever the supply chain issues are out of control. The Federal Reserve is not in control of global energy and commodities prices.


Bond Market Performance 2023

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Sources: Scotia Bank, TC, FT

Note these charts, opinions, news, estimates and times are subject to change and for indication only. Trade and invest at your own risk.

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