Bond Traders Weekly Outlook: Bond Markets Moving with Chaotic Trepidation

Bond markets have moved with chaotic trepidation. The three-month/two-year Treasury yield spread inverted a further 25 bps this week to negative 132 bps (most inverted in four decades). Bond traders have the overhang that the U.S. Treasury market since 2008 has been conditioned to discount the possibility of aggressive rate cuts and QE-related Treasury/MBS purchases. Not a healthy scene, given the more manic markets get with bank lending excess the greater the probability of another bout of aggressive monetary stimulus. Meanwhile, The Fed raised rates on Wednesday in the face of an unfolding banking crisis. The ECB, Norges Bank, HKMA and Bank Negara all followed suite.

Hungry Bond Traders

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.

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

Let’s revisit the week that was; we had the second largest bank failure in U.S. history with First Republic, now three of the top four largest failures over just the past two months. Treasury Secretary Yellen told the world of a debt limit “X-date” possibly as early as June 1st. To close out the week we had another stronger-than-expected U.S. jobs report, with the unemployment rate back down to the lowest level since 1969 (3.4%).

Resilient U.S. Economy Added 253,000 Jobs in April, Caution with Large 235,000 Downward Revisions

Treasuries settled the week with gains in most tenors. The 2-yr note yield fell 15 basis points to 3.91% while the 10-yr note yield was unchanged at 3.45%. Crude oil bounced off a level not seen since December 2021, still was down than $5.00/bbl for the week, the U.S. Dollar Index slipped 0.2% to 101.24, losing 0.4% for the week.

Two-year Treasury yields range this week was 4.16% to 3.65% (ending the week at 3.91%). The three-month/two-year Treasury yield spread inverted a further 25 bps this week to negative 132 bps (most inverted in four decades). We did, as a result see some pressure come off the 2s10s spread, which expanded by 15 bps to -46 bps.

End-of-week market pricing had the policy rate at 4.31% for the Fed’s December 13th meeting, 75 basis points below the current Fed funds rate (5.06%). With the expected December rate sinking 16 bps this week, the divergence between Fed and market expectations only widened.

Bank Credit Default Swap (CDS) prices popped this week

  • Bank CDS prices declined moderately Friday.
  • Bank of America CDS trading Thursday near the highest level (124bps) since March 2020 – ending the week up 14 to 117 bps.
  • Wells Fargo CDS still jumped 13 for the week to 116 bps, trading Thursday to the high since March 2020.
  • Morgan Stanley CDS jumped 14 bps this week,
  • Goldman 10 bps, Citigroup eight bps,
  • JPMorgan six bps.
  • High-yield CDS surged 26 bps this week, trading Thursday to a six-week high (516 bps).

Money Market Flows

  • Investment-grade bond funds posted inflows of $322 million, while junk bond funds reported outflows of $1.581 billion (from Lipper).
  • Total money market fund assets surged $47.2bn to a record $5.310 TN, with an eight-week gain of $416bn. Total money funds were up $798bn, or 17.7%, y-o-y.
  • Total Commercial Paper declined $4.2bn to $1.144 TN. CP was up $41bn, or 3.7%, over the past year.

Yield Watch

Friday/Week

  • 2-yr: +18 bps to 3.91% (-15 bps for the week)
  • 3-yr: +21 bps to 3.65% (-13 bps for the week)
  • 5-yr: +14 bps to 3.42% (-12 bps for the week)
  • 10-yr: +10 bps to 3.45% (UNCH for the week)
  • 30-yr: +4 bps to 3.76% (+8 bps for the week)

U.S. Treasuries finished April with solid gains across the curve following the release of the Bank of Japan’s first policy statement under Kazuo Ueda. The BoJ made no changes to its ultra-loose policy, but it replaced a pledge to keep rates at or below current levels with guidance for continued yield curve control with an aim of achieving the price stability target.

Key Rates and Spreads

Rates

  • 10-year Treasury bonds 3.43%, unchanged w/w (1-yr range: 1.66-4.25) (12 year high)
  • Credit spread 2.18%, up +0.01 w/w (1-yr range: 1.76-2.42)
  • BAA corporate bond index 5.61%, up +0.01 w/w (1-yr range: 4.84-6.59) (10 year+ high)
  • 30-Year conventional mortgage rate 6.50%, down -0.09% w/w (1-yr range: 5.05-7.38) (new 20 year high)

Yield Curve

  • 10-year minus 2-year: -0.48%, up +0.12% w/w (1-yr range: -0.86 – 1.59) (new 40 year low)
  • 10-year minus 3-month: -1.82%, down -0.15% w/w (1-yr range: -1.17 – 2.04) (new low)
  • 2-year minus Fed funds: -1.17%, down -0.34% w/w
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y)

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%.
  • 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.

US corporate bond spreads over US Treasuries and how they have widened as cyclical risk have risen but are well shy of the wide spreads 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 declined $32.4bn last week to $8.539 TN.
  • Fed Credit was down $362bn from the June 22nd peak.
  • Over the past 189 weeks, Fed Credit expanded $4.812 TN, or 129%.
  • Fed Credit inflated $5.760 Trillion, or 205%, over the past 546 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt jumped $33.1bn last week to $3.371 TN.
  • “Custody holdings” were down $91bn, or 2.6%, y-o-y.

End-of-week market pricing had the policy rate at 4.31% for the Fed’s December 13th meeting, 75 basis points below the current Fed funds rate (5.06%). With the expected December rate sinking 16 bps this week, the divergence between Fed and market expectations only widened.

Federal Reserve Raises Rates 25bps as Expected, Removes Additional Firming May be Appropriate

Jay Powell’s press conference was ‘uncontroversial’. We did see some contrition from him “We are committed to learning the right lessons from this episode and will work to prevent events like these from happening again.”

A bit late given we have seen indefensible mistakes made in pathetic bank regulation. We had inflation mismanagement that is at risk of historic failure. Banking instability adds to downside economic risks, containing inflation leant the bank, at tleast in this meeting to err on the side of overing crushing the economy. Powell repeatedly reminds the risk of repeating past mistakes, where Fed inflation fights ended prematurely.

The FOMC meeting came in the midst of chaos. There was a strong case for the Fed to put off another rate increase. The unfolding banking crisis ensures tighter credit for an economy already downshifting. The case for hiking rates was equally compelling. Inflation remains elevated, with recent data consistently pointing to sticky price pressures. Friday’s strong payroll data, including NFP 253,000 jobs added and a 0.5% (4.4% y-o-y) gain in Average Hourly Earnings confirmed unrelenting labor market tightness.

Bloomberg’s Mike McKee: “Markets have priced in rate cuts by the end of the year. Do you rule that out?”

Chair Powell: “We on the Committee have a view that inflation is going to come down, not so quickly, but it’ll take some time. And in that world, if that forecast is broadly right, it would not be appropriate to cut rates, and we won’t cut rates. If you have a different forecast – markets have been from time-to-time pricing in quite rapid reductions in inflation – we’d factor that in. But that’s not our forecast. And, of course, the history of the last two years has been very much that inflation moves down [gradually]. Particularly now, if you look at non-housing services, it really, really hasn’t moved much. And it’s quite stable. So, we think we’ll have to – demand will have to weaken a little bit and labor market conditions may have to soften a bit more to begin to see progress there. And, again, in that world, it wouldn’t be appropriate for us to cut rates.”

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 surged 15 bps to 6.49% (up 122bps y-o-y).
  • Fifteen-year rates rose 12 bps to 5.85% (up 133bps).
  • Five-year hybrid ARM rates jumped 19 bps to 5.96% (up 200bps).
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates down six bps to 6.88% (up 150bps).
Mortgage News Daily February 17, 2023

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 14 bps to 4.02% (down 55bps y-t-d).
  • Italian yields added two bps to 4.19% (down 51bps).
  • Spain’s 10-year yields increased two bps to 3.38% (down 14bps).
  • German bund yields declined two bps to 2.29% (down 15bps).
  • French yields slipped a basis point to 2.88% (down 10bps).
  • he French to German 10-year bond spread widened one to 59 bps.
  • U.K. 10-year gilt yields rose six bps to 3.78% (up 11bps).

This all happened quickly…. just months 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 gained three bps to 0.42% (unchanged 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)
Deja Vu as Dollar Yen Soars After Bank of Japan Keeps Monetary Policy Steady, No Change to JGB Yield Band

Key US Bond Auctions

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

US Core PCE Inflation Held Steady at Persistently High Levels in March
US Producer Price Inflation Fell Again in March, -0.5% m/m vs 0.0% Expected
Consumer Inflation in March Eases, Higher Shelter Prices Offsetting Fall in Energy Costs
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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Real Time Economic Calendar provided by Investing.com.

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Sources: Scotia Bank, TC

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