Bond Traders Weekly Outlook: 10 Year Yields at Year Lows with Cooling Economy

U.S. Treasuries yields continue to respond to risk on/off pressures intraday in the short tenors and further out the curve to recessionary risks. This was highlighted Friday in a thin market by the two-year note, which is highly sensitive to monetary policy expectations. With stocks closed and bonds open for a shortened session for Good Friday moves were exaggerated, The U.S. March jobs report showed a cooling but still strong labor market. The 10-year U.S. Treasury yield jumped to 3.379%, from 3.288% the prior day. The yield on the two-year note rose to 3.948% from 3.818%. Both yields have plunged in recent weeks as bond prices have climbed.

Hungry Bond Traders

There is a firm belief the Central Banks are 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.

Weekly Recap

For the week ten-year Treasury yields declined eight bps this week (in a thin Friday futures yields popped on BLS’s payrolls data) to a 2023 low of 3.39%. At 5.00%, markets are pricing a 70% probability for a 25 bps rate hike on May 3rd. But between then and the FOMC’s December 13th meeting, markets anticipate a dovish pivot with three 25 bps rate cuts.

U.S. March Employment Cools as Expected with Service Jobs Offsetting Technology and Financial Layoffs

For bond traders the big question is the U.S. bank lending boom still intact after the collapse of lending from the regional bank bankruptcies’, or has the Bubble been pierced? These coming weeks bank earnings conference calls will be insightful as will the response of the economy to the huge inflow from the Fed in the past month. Simply, a bubble maintaining an inflationary bias will demonstrate a powerful response to stimulus. The flipside is if the bubble deflates, it will develop increasing resistance to stimulus measures. Was the past month a big enough shock to ‘restart’ the stimulus process?

  • Investment-grade bond funds posted inflows of $1.793 billion, and junk bond funds reported positive flows of $3.773 billion (from Lipper).
  • Total money market fund assets jumped another $49.1bn to a record $5.247 TN, with a four-week gain of $353 billion. Total money funds were up $688bn, or 15.1%, y-o-y.
  • Total Commercial Paper dipped $3.0bn to $1.135 TN. CP was up $68bn, or 6.3%, over the past year.

“Federal Reserve Bank of St. Louis President James Bullard said steps taken to ease financial strains were working and the central bank should keep raising interest rates to fight high inflation. ‘Financial stress seems to be abated, at least for now,’ Bullard told reporters… ‘And so it’s a good moment to continue to fight inflation and try to get on that disinflationary path.’ The St. Louis Fed chief said he doesn’t think tighter credit conditions stemming from the recent banking turmoil will be substantial enough to tip the US economy into recession, noting that demand for loans is still strong.”

April 6 – Bloomberg (Jonnelle Marte)

Two Year Treasury Volatility was Historic in the First Quarter of 2023

  • Two-year Treasury yields began 2023 at 4.43% then fell to 4.10% by February 2nd.
  • Yields then surged almost 100 bps to trade to 5.07% on March 8th. Volatility was on steroids.
  • Yields were down to 3.71% intraday on the 15th, only to rally back to 4.25% on the 17th.
  • They sank to a low of 3.63% on the 20th, back up to 4.25% on the 22nd,
  • Then down to 3.55% on the 24th
  • Ended the quarter at 4.03%.

U.S. Treasuries closed out March modestly higher, adding to their first quarter gains. Shorter tenors earlier faced light selling from China’s best Non-Manufacturing PMI reading since mid-2011, below consensus retail sales in Germany, hotter than expected eurozone CPI, and an upward revision to the U.K.’s Q4 GDP reading.

  • The yield on the 2-year Treasury fell to 4.06%, down 3.7 basis points on Friday and posting the biggest monthly drop since January 2008, in March the yield fell 73.5 basis points. Its first quarterly retreat in eight quarters.
  • The yield on the 10-year Treasury was at 3.491%, off 5.9 basis points, and recording its sharpest monthly fall since March 2020.
  • The yield on the 30-year Treasury declined to 3.688%, down 5.7 basis points, while setting its biggest monthly decline since January.

Bond auctions last week:

We had no bond auctions this past week, just bills.

Yield Watch

  • Three-month Treasury bill rates ended the week at 4.635%.
  • Two-year government yields declined four bps this week to 3.98% (down 45bps y-t-d).
  • Five-year T-note yields dropped eight bps to 3.50% (down 51bps).
  • Ten-year Treasury yields fell eight bps to 3.39% (down 49bps).
  • Long bond yields declined four bps to 3.61% (down 35bps).
  • Benchmark Fannie Mae MBS yields rose three bps to 5.08% (down 31bps).

Key Rates and Spreads

Rates

  • 10-year Treasury bonds 3.41%, down -0.07 w/w (1-yr range: 1.66-4.25) (12 year high)
  • Credit spread 2.03%, down -0.15 w/w (1-yr range: 1.76-2.42)
  • BAA corporate bond index 5.44%, down -0.22 w/w (1-yr range: 4.31-6.59) (10 year+ high)
  • 30-Year conventional mortgage rate 6.18%, down -0.39% w/w (1-yr range: 4.97-7.38) (new 20 year high)

Yield Curve

  • 10-year minus 2-year: -0.58%, down -0.01% w/w (1-yr range: -0.86 – 1.59) (new 40 year low)
  • 10-year minus 3-month: -1.52%, down -0.22% w/w (1-yr range: -1.17 – 2.04) (new low)
  • 2-year minus Fed funds: -0.84%, down -0.11% w/w
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y)

US corporate bond spreads over US Treasuries and how they have widened as cyclical risk have risen but are well shy of the wides recorded during the early part of the pandemic, let alone the GFC. To label this as a severe credit crunch would be extreme.

10 Year Note Technical Analysis via KnovaWave

Highlights – Federal Reserve

  • Federal Reserve Credit dropped $96.9bn last week to $8.599 TN.
  • Fed Credit was down $301bn from the June 22nd peak.
  • Over the past 185 weeks, Fed Credit expanded $4.873 TN, or 131%.
  • Fed Credit inflated $5.788 Trillion, or 206%, over the past 543 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt rose $25.3bn last week to $3.319 TN.
  • “Custody holdings” were down $140bn, or 4.0%, y-o-y.

It’s been four weeks since the implosion of three US banks, Silicon Valley Bank, Signature Bank and Silvergate Capital Corp. From there we saw further selling of Credit Suisse that has never recovered from Archegos and the panic selling and speculative attacks on other US Regional banks. The Federal Reserve has worked in concert with the Treasury and major money center banks to stabilize conditions. The speed of protective measures for the financial system has been impressive but with that longer-run moral hazard problems and adverse incentives are front and center.

Central Bank Watch – Fed, HKMA, BOE, Norges, BSP, CBC and SNB All Hike Rates Amid Banking Crisis

Highlights – Mortgage Market

  • Freddie Mac 30-year fixed mortgage rates gained three bps to 6.27% (up 155bps y-o-y).
  • Fifteen-year rates declined two bps to 5.53% (up 162bps).
  • Five-year hybrid ARM rates slipped a basis point to 5.55% (up 199bps).
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates bps down 19 bps to 6.75% (up 192bps).
Mortgage News Daily February 17, 2023

Key Bond Auctions

Global Bond Watch

“Government bond prices around the world are moving in tandem, reducing investors’ ability to diversify their portfolios and raising concerns of being blindsided by market gyrations. Correlations between currency-adjusted returns on the government debt of countries such as the U.S., Japan, the U.K. and Germany are at their highest level in at least seven years, data from MSCI showed, as central banks around the world ramp up their fight against inflation.”

October 10 – Reuters (Davide Barbuscia)

Major Benchmark 10-year Bond markets

Bond Market Performance 2023

Major 10-year Bonds/Notes

Highlights – European Bonds

Ten-year government yields down significantly.

  • Greek 10-year yields dropped 12 bps to 4.07% (down 49bps y-o-y).
  • Italian yields declined seven bps to 4.03% (down 67bps).
  • Spain’s 10-year yields fell eight bps to 3.23% (down 29bps).
  • German bund yields declined 11 bps to 2.18% (down 26bps).
  • French yields fell nine bps to 2.70% (down 28bps).
  • The French to German 10-year bond spread widened two to 52 bps.
  • U.K. 10-year gilt yields declined six bps to 3.43% (down 26bps). 

This all happened quickly…. just weeks ago we had:

German 10-Year Bunds at Weakest Level since July 2011 as Yield Curve Inversion Deepens

Highlights – Asian Bonds

  •  Japanese 10-year “JGB” yields surged 12 bps to 0.47% (up 5bps y-t-d)

“The unprecedented monetary easing by the Bank of Japan over the past decade has reshaped the nation’s lenders, from their asset holdings to loan income. That may be about to change as the central bank prepares to take on a new chief next month… The most notable case is Japan Post Bank Co., a unit of a former state-run mail services giant, which manages most of almost $2 trillion of assets in its securities portfolio. Where it once invested as much as 80% of its money in JGBs, this now accounts for less than 20%. Instead, the bank has rapidly built up its holdings of foreign bonds and other securities to 78 trillion yen ($572bn), accounting for about 35% of its entire portfolio.”

March 5 – Bloomberg (Taiga Uranaka)
Dollar Yen Soars After Bank of Japan Keeps Monetary Policy Steady, No Change to JGB Yield Band

Inflation Matters

Inflation with Henry Kaufman

Kaufman is the legendary chief economist and head of bond market research at Salomon Brothers is someone who knows Inflation.  Henry Kaufman in an interview with Bloomberg’s Erik Schatzker Jan 14, 2022:

 “I don’t think this Federal Reserve and this leadership has the stamina to act decisively. They’ll act incrementally. In order to turn the market around to a more non-inflationary attitude, you have to shock the market. You can’t raise interest rates bit-by-bit.”

“The longer the Fed takes to tackle a high rate of inflation, the more inflationary psychology is embedded in the private sector — and the more it will have to shock the system.”

“‘It’s dangerous to use the word transitory,’ Kaufman said. ‘The minute you say transitory, it means you’re willing to tolerate some inflation.’ That, he said, undermines the Fed’s role of maintaining economic and financial stability to achieve ‘reasonable non-inflationary growth.’”

Inflation, Disinflation

FAO World Food Price Index Fell in March for Twelfth Consecutive Month
US Core PCE Inflation Comes in Lighter Than Expected in February
US Producer Price Inflation Fell in February as Economy Faces Headwinds
Modest Pullback in US Consumer Inflation in February as Core Services Prices Climb
FAO World Food Price Index Fell in March for Twelfth Consecutive Month

The rubber is meeting the road as the trifecta of rising interest rates, the Russian invasion of Ukraine and surging costs continues to weigh, this has been no surprise to us here and shouldn’t have been to the market and PTB. You can only play with fire for so long before you get scorched!

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.

Everything points to powerful inflationary dynamics and a Federal Reserve so far “behind the curve.”

Instability is pronounced, credit defaults are on track to rise in North America, Europe, Asia, and Australia, according to a survey by the International Association of Credit Portfolio Managers. The economic slump is likely to occur later this year or in 2023, according to the survey.

Global Bonds 2022 Performance

10 Year Bonds – Americas 2022 Performance

10 Year Bonds – Europe 2022 Performance

10 Year Bonds – Asia 2022 Performance

10 Year Bonds – Africa 2022 Performance

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Sources: Scotia Bank, TC

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