Bond Traders Weekly Outlook: Bond Market Has Not Bought into Fed’s Tightening Cycle Over

In a week of mostly soft data U.S. Treasuries on Friday finished broadly lower lifting yields off their lowest levels in three weeks, though still stronger on the week mostly. U.S. Treasuries completed this week’s note auctions with strong demand with no issues. Post the Employment report for August the initial rally pressured yields to levels not seen since the first full week of August with the 5-yr yield slipping below its 50-day moving average (4.211%), but the market reversed swiftly with longer tenors leading the slide. What stands out to us is bonds are just not seeing much benefit from changes in Fed rate policy expectations.

Longer-term bonds reacted meekly to weak data, 30-year long bond Treasury yields were up a basis point this week to 4.30%, even as two-year yields sank 20 bps to 4.87%. The rates market says the Fed’s tightening cycle is likely over, yet bonds have not fully bought it or is the overhanging heavy supply the devil in all this?

Hungry Bond Traders

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.

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

U.S. Treasuries on Friday finished broadly lower lifting yields off their lowest levels in three weeks. U.S. Treasuries completed this week’s note auctions with strong demand with no issues. Post the Employment report for August the initial rally pressured yields to levels not seen since the first full week of August with the 5-yr yield slipping below its 50-day moving average (4.211%), but the market reversed swiftly with longer tenors leading the slide. The 10-year’s immediate five bps yield decline had fully reversed within an hour. For all the weaker data, 10-year bond yields declined a measly six bps this week, with Friday’s closing yield (4.18%) only 16 bps below the 16-year closing high (4.34%) from nine sessions ago (August 21st). Longer-term bonds reacted meekly to weak data, 30-year long bond Treasury yields were up a basis point this week to 4.30%, even as two-year yields sank 20 bps to 4.87%.

Jumps in the ISM Manufacturing Survey’s Employment (48.5 vs. July’s 44.4) and Price (48.4 vs. 42.6) perhaps spooking traders, but it has been a week of soft data mostly. Ten-year Treasury yields ended the session up seven bps to 4.18%. The long bond finished unchanged for the week while shorter tenors narrowed their recent gains.

As of Tuesday, markets saw a 22% probability of a rate hike at the Fed’s September 20th meeting, with an additional 48% for the November 1st meeting. This 70% probability for one additional Fed increase had sunk to 38% by Friday’s close (7% for September and 31% November).

What stand out to us is bonds are just not seeing much benefit from changes in Fed rate policy expectations. The rates market says the Fed’s tightening cycle is likely over, yet bonds have not fully bought it or is the overhanging heavy supply the devil in all this?

Corporate risk premiums narrowed further this week.

  • Investment-grade spreads (to Treasuries) were little changed at 1.19 percentage points (near low since February ‘22)
  • Investment-grade CDS traded down to 62 bps in Wednesday trading, just above lows back to February 2022.
  • High yield spreads narrowing 14 bps to 3.66 – the low since April ’22.
  • High yield CDS dropped 16 this week to 422 bps, trading at about the same level as in April 2022 (as the Fed commenced “tightening”).

This week’s action alleviated some more pressure on the 2s10s spread, expanding it by ten basis points to -71 bps. Crude oil climbed for the seventh day in a row, rising past $85.00/bbl, to a level not seen since mid-November. The U.S. Dollar Index reclaimed the remainder of this week’s loss. The Index rose 0.6% to 104.23 today, finishing the week unchanged.

Key Catalysts that empowered latest Treasury sell off:

“Based on projected intermediate- to long-term borrowing needs, Treasury intends to gradually increase coupon auction sizes beginning with the August to October 2023 quarter. While these changes will make substantial progress towards aligning auction sizes with intermediate- to long-term borrowing needs, further gradual increases will likely be necessary in future quarters.”

August 11 – Bloomberg (Farah Elbahrawy and Greg Ritchie): “US Treasuries are on course for a record year of inflows as investors chasing some of the highest yields in months pile into cash and bonds, according to Bank of America… Cash funds attracted $20.5 billion and investors poured $6.9 billion into bonds in the week through August 9… Meanwhile, US stocks had their first outflow in three weeks at $1.6 billion. Flows into Treasuries have reached $127 billion this year, set for an annualized record of $206 billion, BofA said.”

Yield Watch

Friday/Week

  • 2-yr: +2 bps to 4.88% (-17 bps for the week)
  • 3-yr: +4 bps to 4.57% (-17 bps for the week)
  • 5-yr: +5 bps to 4.29% (-14 bps for the week)
  • 10-yr: +8 bps to 4.17% (-7 bps for the week)
  • 30-yr: +8 bps to 4.29% (UNCH for the week)

Key Rates and Spreads

Rates

  • 10-year Treasury bonds 4.12%, down -0.07% w/w (2.60-4.34) (new 10-year high intraweek w/e 8/21/23)
  • Credit spread 1.82%, down -0.02 w/w (1-yr range: 1.76-2.42)
  • BAA corporate bond index 5.94%, down -0.09% w/w (1-yr range: 5.13-6.59) (10 year+ high)
  • 30-Year conventional mortgage rate 7.08%, down -0.31% w/w (5.05-7.39) (new 20+ year high 8/25/23 w/e)

Yield Curve

  • 10-year minus 2-year: -0.70%, up +.15% w/w (1-yr range: -1.06 – 1.59) (new 40 year low)
  • 10-year minus 3-month: -1.27%, down -.08% w/w (1-yr range: -1.69 – 2.04) (new low)
  • 2-year minus Fed funds: -0.45%, down -0.20% w/w
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y)

Money Market Flows

  • Investment-grade bond funds posted outflows of $971 million, while junk bond funds reported inflows of $1.214 billion (from Lipper).
  • Total money market fund assets increased $14bn to a record $5.583 TN, with a 25-week gain of $689bn (29% annualized). Total money funds were up $1.015 TN, or 22.2%, y-o-y.
  • Total Commercial Paper jumped $21.7bn to a five-month high $1.185 TN. CP was down $14bn, or 1.2%, over the past year.

Bond auctions this week:

Bond auctions week ahead:

Next week will bring some new supply.

  • Monday: All Day Holiday United States – Labor Day
  • Tuesday: 13- and 26-week bills,
  • Wednesday: 52-week bills; 42-day CMB 17-week bills;
  • Thursday: 4- and 8-week bills

10 Year Note Technical Analysis via KnovaWave

Highlights – Federal Reserve

  • Federal Reserve Credit declined $19.9bn last week to $8.087 TN.
  • Fed Credit was down $813bn from the June 22nd, 2022, peak.
  • Over the past 207 weeks, Fed Credit expanded $4.360 TN, or 117%.
  • Fed Credit inflated $5.277 TN, or 188%, over the past 564 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt declined $4.5bn last week to a one-month low $3.436 TN.
  • “Custody holdings” were up $45bn, or 1.3%, y-o-y.

Powell at the FOMC: “The federal-funds rate is at a restrictive level now. So, if we see inflation coming down credibly, sustainably, then we don’t need to be at a restrictive level anymore. We can move back to a neutral level and then below a neutral level at a certain point… And you’d start cutting before you got to 2% inflation too. Because we don’t see ourselves getting to 2% inflation until—you know, all the way back to 2 until 2025 or so.”

Highlights – Mortgage Market

  • Freddie Mac 30-year fixed mortgage rates rose eight bps to 7.30% (up 175bps y-o-y) – the high back to 2002.
  • Fifteen-year rates gained eight bps to 6.73% (up 188bps).
  • Five-year hybrid ARM rates surged 40 bps to 7.11% (up 275bps).
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates unchanged at 7.58% (up 171bps).
Mortgage News Daily

Global Bond Watch

Higher for longer is a serious threat.

Global Yields Spiking Higher

Surging market yields are a serious issue for a banking system loaded with long duration securities portfolios. This may well be a push over the cliff for troubled commercial real estate (CRE). Leveraged lending and leveraged finance gets more costly. Simply there are trillions of floating rate loans among individuals, speculators, businesses, and nations.

Contagion Emerging Market (EM) bond yields reversed sharply higher.

Emerging Market (EM) CDS jumped 19 to 222 bps, the largest weekly gain since the banking crisis week of March 17th.

(August 18,2023)

  • Vietnam CDS rose 13 to 128 bps,
  • Philippines 12 to 114 bps, Indonesia 12 to 93 bps.
  • Panama CDS surged 21 (largest gain since September 2022) to 118 bps,
  • Colombia 21 (largest since March) to 229 bps,
  • Brazil 18 (March) to 192 bps, Peru 16 (March) to 87 bps,
  • Mexico 10 (March) to 115 bps.

Dollar denominated EM debt surged higher

  • Peru jumped 27 bps to a five-month high 5.67%;
  • Philippines 31 bps to a five-month high 5.26%;
  • Indonesia 29 bps to a nine-month high 5.27%;
  • Brazil 23 bps to a near 10-month high 6.59%;
  • Mexico 19 bps to a nine-month high 5.95%;
  • Chile 22 to a nine-month high 5.42%.

Local currency yields

  • 132 bps in Brazil to a two-month high 11.24%.
  • Mexico yields jumped 27 bps to 9.33%,
  • Colombia surged 46 bps to 10.89%.

Crude oil bounced off its 50-day moving average (71.29), rising toward its June high (75.06). With the pullback in yields the U.S. Dollar Index fell 0.9% to 102.28 through its 50-day moving average (102.92), resulting in a 0.6% loss for the week.

Major Benchmark 10-year Bond markets

Bond Market Performance 2023

Major 10-year Bonds/Notes

Highlights – European Bonds

  • Greek 10-year yields declined four bps to 3.83% (down 74bps y-t-d).
  • Italian yields were unchanged at 4.24% (down 46bps).
  • Spain’s 10-year yields slipped a basis point to 3.58% (up 6bps).
  • German bund yields declined a basis point to 2.55% (up 11bps).
  • French yields dipped two bps to 3.07% (up 9bps).
  • The French to German 10-year bond spread narrowed one to 52 bps.
  • U.K. 10-year gilt yields declined a basis point to 4.43% (up 76bps)

Gilts Sold Reminds of Risk.

(We keep this as a reminder so events like Fitch’s downgrade of the US are not a Surprise)

Post ADP, Pre-June CPI/PPI Dropped:

  • UK 10-year yields were up 16 bps Thursday to 5.54%, with two-year yields surging as much as 18 bps to a 15-year high 5.54%. Reminiscent of last fall, UK yields were pulling global yields higher – even before the jolt from strong U.S. data.
  • Italian 10-year yields surged 21 bps Thursday (4.37%),
  • Greek yields jumped 18 bps (3.97%).
  • Ten-year yields rose 17 bps in Spain (3.70%) and Portugal (3.36%).
  • Canadian 10-year yields surged 30 bps this week to an eight-month high of 3.57%.
  • Australian 10-year yields jumped 23 bps this week to 4.26% – the high since January 2014.
  • New Zealand yields rose 22 bps to 4.85% – the high since July 2011.

The UK’s 10-year bond yields are the highest in the G7, 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 declined three bps to 0.63% (up 21bps y-t-d).

The Bank of Japan and its new Governor felt compelled to do, so, it tinkered with YCC (yield curve control), cleverly achieving some flexibility without unleashing a panic. Ueda adjusting a policy after signaling no move would be forthcoming left the markets feeling ‘betrayed’. There was a leak the day before the meeting. Ueda stated the YCC tweak “didn’t represent a step toward normalization” and the “BOJ still sees a long way to achieving price goal.” Ah, huh … the market sighed collectively.

July 28 – Financial Times (Kana Inagaki, Leo Lewis and Hudson Lockett): “The Bank of Japan has eased controls on its government bond market, altering a cornerstone of its ultra-loose monetary policy and prompting a surge in the country’s benchmark bond yields to the highest level in nine years. In an unexpected move, the BoJ said it would offer to buy 10-year Japanese government bonds at 1% in fixed-rate operations, in effect widening the trading band on long-term yields. The central bank added that it was technically maintaining its previous 0.5% cap on 10-year bond yields, but this level would be a ‘reference’ rather than a ‘rigid limit’. The move triggered confusion about whether the central bank would make further moves to unwind its easing policy, which has come under pressure this year from inflation that has hit four-decade highs. But the BoJ held its overnight rate at minus 0.1%, saying more time was needed to sustainably achieve its 2% inflation target.”

Key US Bond Auction Highlights

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

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, 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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