Bond Traders Weekly Outlook: Bonds markets Curve Impacted by Fed Contradiction on Rate Cuts

U.S. Treasuries closed the week adversely impacted at the front of the curve after New York Fed President Williams (FOMC voter) seemingly contradicting Fed Chair Powell when he told CNBC the Fed hasn’t really talking about rate cuts right now. Powell at the FOMC presser Wednesday said the FOMC discussed when it would be appropriate to dial back policy restraint. Atlanta Fed President Bostic (2024 FOMC voter) told Reuters, meanwhile, that he expects two rate cuts in 2024, starting in the second half of the year. The fed funds futures market is pricing in six rate cuts beginning in March. Longer-dated tenors were supported by soft industrial production data for November, a dip in the preliminary S&P Global US Manufacturing PMI for December to 48.2 from the final reading of 49.4 for November.

Hungry Bond Traders

We had three large Treasury auctions, following weak 3- and 10-yr notes auctions we saw a strong long bond auction which the Fixed Interest desk rated it an A. It was a central bank overload with over a dozen central banks including FOMC, BoK, BCB, BoE, ECB, SNB & Norges Bank Policy Announcements. The Fed was the lone central bank with speculation on rate cuts this week which sent the bond and stock markets on fire, with the Dow hitting an all-time high Wednesday. The ECB and BoE pushed back while others offered mixed perspectives including Norges Bank’s surprise hike.

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.

Losses on longer-dated Treasuries are beginning to rival some of the most notorious market meltdowns in US history. Bonds maturing in 10 years or more have slumped 46% since peaking in March 2020… That’s just shy of the 49% plunge in US stocks in the aftermath of the dot-com bust at the turn of the century. The rout in 30-year bonds has been even worse, tumbling 53%, nearing the 57% slump in equities during the depths of the financial crisis.” October 4 – Bloomberg (Ye Xie)

Weekly Recap

The Treasury market had a strong rally in response to the Fed’s dovish pivot. The loosening of conditions was already telling and then we got the “pivot.” The 2-yr note yield dropped 28 basis points to 4.46% and the 10-yr note yield plunged 30 basis points to 3.93%. The 10-yr note yield falling below 4.00% acted as added support for equities this week. U.S. Treasuries closed the week adversely impacted at the front of the curve after New York Fed President Williams (FOMC voter) seemingly contradicting Fed Chair Powell when he told CNBC the Fed hasn’t really talking about rate cuts right now.

Powell at the FOMC presser Wednesday said the FOMC discussed when it would be appropriate to dial back policy restraint. Atlanta Fed President Bostic (2024 FOMC voter) told Reuters, meanwhile, that he expects two rate cuts in 2024, starting in the second half of the year. The fed funds futures market is pricing in six rate cuts beginning in March. Longer-dated tenors were supported by soft industrial production data for November, a dip in the preliminary S&P Global US Manufacturing PMI for December to 48.2 from the final reading of 49.4 for November.

We had three large Treasury auctions, following weak 3- and 10-yr notes auctions we saw a strong long bond auction which the Fixed Interest desk rated it an A. It was a central bank overload with over a dozen central banks including FOMC, BoK, BCB, BoE, ECB, SNB & Norges Bank Policy Announcements. The Fed was the lone central bank with speculation on rate cuts this week which sent the bond and stock markets on fire, with the Dow hitting an all-time high Wednesday. The ECB and BoE pushed back while others offered mixed perspectives including Norges Bank’s surprise hike.

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.

Key Catalysts that empowered this year’s 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.”

September 19 – Reuters (Rodrigo Campos): Global debt hit a record $307 trillion in the second quarter of the year despite rising interest rates curbing bank credit, with markets such as the United States and Japan driving the rise, the Institute of International Finance (IIF) said… The financial services trade group said… global debt in dollar terms had risen by $10 trillion in the first half of 2023 and by $100 trillion over the past decade. It said the latest increase has lifted the global debt-to-GDP ratio for a second straight quarter to 336%. Prior to 2023, the debt ratio had been declining for seven quarters.”

Yield Watch

Friday/Week

  • 2-yr: +6 bps to 4.46% (-28 bps for the week)
  • 3-yr: +6 bps to 4.15% (-31 bps for the week)
  • 5-yr: +3 bps to 3.93% (-31 bps for the week)
  • 10-yr: unch at 3.93% (-30 bps for the week)
  • 30-yr: -3 bps to 4.03% (-28 bps for the week)

Key Rates and Spreads

Rates

  • 10-year Treasury bonds 3.92%, down -0.31% w/w (3.30-4.99) (new 15 year high 10/20/23 w/e)
  • Credit spread 1.57%, up +0.03% w/w (1.54-2.42) (1.64-2.42) (new 1 year low 12/7/23 w/e)
  • BAA corporate bond index 5.49%, down -0.28% w/w (6+ month low) (1-yr range: 5.28-6.80) (14 year+ high w/w 10/20/23)
  • 30-Year conventional mortgage rate 6.64%, down -0.45% w/w (6 month low). (6.07-8.03) (new 23 year high 10/20/23 w/e)

Yield Curve

  • 10-year minus 2-year: -0.53%, down -0.30% w/w (1-yr range: (-1.07 – -0.17) (new 40 year low)
  • 10-year minus 3-month: -1.48%, down -0.32 w/w (1-yr range: -1.89 – 0.21)
  • 2-year minus Fed funds: -0.90%, down -0.03% w/w.
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y)

Money Market Flows

  • Total money market fund assets declined $11.6bn to $5.886 TN, with a 40-week gain of $992bn (26% annualized).
  • Money funds were up $1.168 TN, or 24.8%, y-o-y.
  • Total Commercial Paper declined $8.3bn to $1.243 TN. CP was down $59bn, or 4.6%, over the past year.

Bond auctions this week:

Bond auctions week ahead:

Next week will bring some new supply.

  • Monday: 13- and 26-week bills,
  • Tuesday:  52-Week 42-day cash management bills,
  • Wednesday: 4- and 8-week bills; 17-week bills; $13 bln 20-Yr Bond Auction
  • Thursday: 4- and 8-week bills

A gauge of auction strength we keep our eye on is bid-to-cover ratios.

These have recently weakened as bonds sold off). With this swift move in rates, we watch to see if the market chases lower yields with stronger bid-to-cover ratios. That could be more consequential than anything else in an otherwise lighter than usual week for data and news, that said the Fed speakers are back out in force.

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.

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

Highlights – Federal Reserve

  • Federal Reserve Credit increased $4.5bn last week to $7.702 TN.
  • Fed Credit was down $1.999 TN from the June 22nd, 2022, peak.
  • Over the past 222 weeks, Fed Credit expanded $3.975 TN, or 107%.
  • Fed Credit inflated $4.891 TN, or 174%, over the past 579 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt increased $2.5bn last week to $3.389 TN.
  • “Custody holdings” were up $80.1bn, or 2.4%, y-o-y.

Powell at the FOMC:

“Our actions have moved our policy rate well into restrictive territory, meaning that tight policy is putting downward pressure on economic activity and inflation, and the full effects of our tightening likely have not yet been felt.”

“So we’re aware of the risk that we would hang on too long. We know that that’s a risk, and we’re very focused on not making that mistake.”

BUT Powell’s own comments are contradictory. “GDP is on track to expand around 2-1/2 percent for the year as a whole, bolstered by strong consumer demand as well as improving supply conditions.” “Committee participants revised up their assessments of GDP growth this year…” “The labor market remains tight… labor demand still exceeds the supply of available workers.” “…A very high proportion of forecasters predicted very weak growth or a recession. Not only did that not happen, we actually had a very strong year…” “So we’ve seen… strong growth, still a tight labor market…”

Highlights – Mortgage Market

  • Freddie Mac 30-year fixed mortgage rates increased two bps to 6.82% (up 65bps y-o-y).
  • Fifteen-year rates were unchanged at 6.27% (up 75bps).
  • Five-year hybrid ARM rates slipped two bps to 6.62% (up 126bps).
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates down 23 bps to a five-month low 7.25% (up 64bps).
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.

Major Benchmark 10-year Bond markets

Bond Market Performance 2023

Major 10-year Bonds/Notes

Highlights – European Bonds

  • Italian yields sank 35 bps to 3.72% (down 98bps).
  • Greek 10-year yields dropped 28 bps to 3.16% (down 140bps y-t-d).
  • Spain’s 10-year yields fell 31 bps to 3.00% (down 52bps).
  • German bund yields dropped 26 bps to 2.02% (down 43bps).
  • French yields sank 28 bps to 2.55% (down 43bps).
  • The French to German 10-year bond spread narrowed two to 53 bps.
  • U.K. 10-year gilt yields collapsed 35 bps to 3.69% (up 1bp).

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 fell seven bps to 0.70% (up 27bps y-t-d).

Key US Bond Auction Highlights

Strong 30-year Treasury Bond Auction Completes Week’s Offerings Ahead of FOMC

Underwhelming U.S. 10-year Bond Auction Follows Earlier Soft 3-year Sale

International Buyers Step Away in Weak 3-year Treasury Note Auction Ahead of CPI

Weak Demand at 7-year Treasury Bond Auction with 2.1 bps Tail Completes Week’s Offerings

Weak Demand in 5-Year Treasury Auction Amongst Continued Bond Selling

Steady Demand at 2 Year Treasury Notes Auctions Among Heavy Supply

Woeful 30-year Treasury Bond Auction with Record 5.3 bps Tail Completes Week’s Offerings

U.S. 10-year Bond Auction Auctioned at 4.61%, Highest Yield at Auction Since 2007 Ahead of CPI

Dismal 3-year Bond Auction in Another Week of Heavy Supply Gets an F Rating

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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