Bond Traders Weekly Outlook: 2-year Treasury Yield fell 73.5bps in March, Biggest Monthly Drop Since January 2008

U.S. Treasuries closed out March modestly higher, adding to their first quarter gains. 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. Money Market assets surged a stunning $304 billion in three weeks to a record $5.198 TN. Treasuries advanced to fresh highs and continued building on their gains after the much-watched Personal Income/Outlays report for February showed some disinflation. The PCE Price Index slowing to 5.0% yr/yr from 5.3% in January while the core-PCE Price Index dipped to 4.6% from 4.7%. The University of Michigan one-year inflation expectations fell to 3.6% from 3.8% in the preliminary March reading and 4.1% in the final February reading.

Crude oil bounced to $75.72, narrowing its March loss to $2.69 or 3.5% (-$5.13 or -6.4% in Q1). The U.S. Dollar Index rose 0.4% to 102.52, trimming this week’s loss to 0.6%. The Index lost 2.3% in March and was down 0.9% for the quarter.

Hungry Bond Traders

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%.

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.

Markets began the year pricing 38 bps of rate cuts between the May 3rd and December 13th FOMC meetings. By March 8th, this had shifted to 20 bps of additional tightening. A week later (March 15), markets were pricing 106 bps of rate cuts. By quarter end, expectations were for rates to drop 39 bps.

Weekly Recap

  • Investment-grade bond funds posted outflows of $881 million, and junk bond funds reported negative flows of $2.135 billion (from Lipper).
  • Total money market fund assets jumped $66bn to a record $5.198 TN, with a three-week gain of $304 billion. Total money funds were up $608bn, or 13.2%, y-o-y.
  • Total Commercial Paper recovered $19.5bn to $1.138 TN. CP was up $75bn, or 7.1%, over the past year.

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.

Treasuries advanced to fresh highs and continued building on their gains after the much-watched Personal Income/Outlays report for February showed some disinflation. The PCE Price Index slowing to 5.0% yr/yr from 5.3% in January while the core-PCE Price Index dipped to 4.6% from 4.7%. The University of Michigan one-year inflation expectations fell to 3.6% from 3.8% in the preliminary March reading and 4.1% in the final February reading.

U.S. Treasuries completed this week’s note auctions with a weak $35 bln 7-yr note auction. U.S. Treasuries felt some pressure after the recent completion met lukewarm demand. The sale drew a high yield of 3.626%, which tailed the when-issued yield by 1.1 bps, the bid-to-cover ratio (2.39x) and indirect takedown (63.2%) were below average. The fixed interest desk rated the auction a D. Earlier treasuries traded off their lows after the completion of today’s $43 bln 5-yr note auction which met solid demand after a soft 2-yr note sale.

Bond auctions last week:

Weak International Demand in U.S. 7-year Treasury Bond Auction Completes Week’s Offerings
5-Year Treasury Auction Attracts Strong International Demand
Soft 2-year Treasury Bond Auction with 2.7bps Tail

Inflation, Disinflation

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 February for Eleventh Consecutive Month

Yield Watch

  • 2-yr: -5 bps to 4.06% (+29 bps for the week; -74 bps in March; -36 bps for Q1)
  • 3-yr: -6 bps to 3.83% (+24 bps for the week; -68 bps in March; -41 bps for Q1)
  • 5-yr: -5 bps to 3.61% (+20 bps for the week; -56 bps in March; -39 bps for Q1)
  • 10-yr: -6 bps to 3.49% (+11 bps for the week; -43 bps in March; -39 bps for Q1)
  • 30-yr: -6 bps to 3.69% (+5 bps for the week; -24 bps in March; -29 bps for Q1)

Key Rates and Spreads

Rates

  • 10-year Treasury bonds 3.38%, down -0.03 w/w (1-yr range: 1.66-4.25) (12 year high)
  • Credit spread 2.18%, down -0.08 w/w (1-yr range: 1.76-2.42)
  • BAA corporate bond index 5.66%, up +0.02 w/w (1-yr range: 4.20-6.59) (10 year+ high)
  • 30-Year conventional mortgage rate 6.57%, up +0.19% w/w (1-yr range: 4.29-7.38) (new 20 year high)

Yield Curve

  • 10-year minus 2-year: -0.57%, down -0.17% w/w (1-yr range: -0.86 – 1.59) (new 40 year low)
  • 10-year minus 3-month: -1.30%, unchanged w/w (1-yr range: -1.17 – 2.04) (new low)
  • 2-year minus Fed funds: -0.73%, up +0.28% 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 jumped $38.1bn last week to a five-month high $8.696 TN – with a three-week gain of $391bn.
  • Fed Credit was down $205bn from the June 22nd peak.
  • Over the past 185 weeks, Fed Credit expanded $4.969 TN, or 133%.
  • Fed Credit inflated $5.885 Trillion, or 209%, over the past 542 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt fell $15.5bn last week to $3.293 TN – the low back to June 2017.
  • “Custody holdings” were down $170bn, or 4.9%, y-o-y.

It’s been three 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 dropped 15 bps to a seven-week low 6.24% (up 157bps y-o-y).
  • Fifteen-year rates declined seven bps to 5.55% (up 172bps).
  • Five-year hybrid ARM rates added a basis point to 5.56% (up 206bps).
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates up six bps to 6.94% (up 203bps).
Mortgage News Daily February 17, 2023

Key Bond Auctions

Bond auctions last week:

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 jumped 13 bps to 4.19% (down 37bps y-o-y).
  • Italian yields gained nine bps to 4.10% (down 60bps).
  • Spain’s 10-year yields rose 12 bps to 3.30% (down 21bps).
  • German bund yields jumped 16 bps to 2.29% (down 15bps).
  • French yields gained 14 bps to 2.79% (down 190bps).
  • The French to German 10-year bond spread narrowed about two to 50 bps.
  • U.K. 10-year gilt yields surged 21 bps to 3.49% (down 18bps).

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 rose three bps to 0.32% (down 11bps 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.’”

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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