Bond Traders Weekly Outlook: Continued Under Performance By 2-yr Note

U.S. Treasuries sold off all week until Friday. At one point the entire curve was over 4%. Ten-year Treasury yields traded as high as 4.09% the highest since November 9th. Benchmark MBS yields rose to 5.67%, up 100 bps over the past month, the highest since the ninth of November. Then on Friday a reversal lifted the long bond into positive territory for the week while shorter tenors recovered some of their losses from the past two days. Another week of under performance in the 2-yr note, putting more pressure on the 2s10s spread, which tightened by seven basis points to -90 bps.

Of note eurozone’s PPI decreased 2.8% in January against expectations for a much smaller dip, slowing the yr/yr growth rate to 15.0% from 24.6% in December. WTI crude oil bounced back to its February high, up 4.79% for the week and natural gas continued its strong bounce, rising 18.5% for the week. The U.S. Dollar Index fell 0.5% to 104.50, losing 0.7% for the week.

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.

The market is now pricing peak Fed funds at 5.40% for the June 24th FOMC meeting, up 12 bps this week and 56 bps since February 2nd. Expectations for the December meeting policy rate jumped 22 bps this week (up 88bps in three weeks) to 5.28%. Market pricing now has consecutive rate increases at the March, May and June FOMC meetings, with about a 20% probability for a 50-bps hike next month.

Weekly Recap

U.S. Treasuries sold off all week until Friday. At one point the entire curve was over 4%. Friday saw a reversal lifting the long bond into positive territory for the week while shorter tenors recovered some of their losses from the past two days. Of note eurozone’s PPI decreased 2.8% in January against expectations for a much smaller dip, slowing the yr/yr growth rate to 15.0% from 24.6% in December. Another week of under performance in the 2-yr note, putting more pressure on the 2s10s spread, which tightened by seven basis points to -90 bps.

Investment-grade corporate yield spreads to Treasuries closed the week 32 bps lower than November 9th at 120 bps (2023 low 115bps). JPMorgan CDS ended Friday at 65 bps, Goldman at 83 bps, and Bank of America at 69 bps, down significantly from November 9th levels of 90, 120, and 97 bps, respectively.

WTI crude oil bounced back to its February high, up 4.79% for the week and natural gas continued its strong bounce, rising 18.5% for the week. The U.S. Dollar Index fell 0.5% to 104.50, losing 0.7% for the week

Bond auctions this week: $40 bln 3-yr Treasury note auction results Tuesday, Wednesday the $32 bln 10-yr Treasury note reopening results at 13:00 ET; Thursday the $18 bln 30-yr Treasury bond auction results at 13:00 ET

Inflation, Disinflation

The ISM Non-Manufacturing Index for February increased to 55.1%, ahead of a consensus 54.5% and just under 55.2% in January. The prices paid index 65.6 versus 64.5 expected. Prior 67.8. The US services sector expanded in February for the second consecutive month. Business activity for the services sector, which comprises the largest component of U.S. economic activity, has quickly rebounded into growth mode after contracting for the first time since May 2020 in December.

US Services Sector PMI Continues Return To Expansion in February – ISM

Yield Watch

  • 2-yr: -5 bps to 4.86% (+8 bps for the week)
  • 3-yr: -4 bps to 4.60% (+9 bps for the week)
  • 5-yr: -7 bps to 4.25% (+4 bps for the week)
  • 10-yr: -11 bps to 3.96% (+1 bp for the week)
  • 30-yr: -13 bps to 3.89% (-5 bps for the week)
  • Investment-grade bond funds posted outflows of $238 million, and junk bond funds reported negative flows of $2.310 billion (from Lipper).
  • Total money market fund assets surged $73.4bn to $4.894 TN. Total money funds were up $288bn, or 6.2%, y-o-y.
  • Total Commercial Paper dropped $23.8bn to $1.214 TN. CP was up $187bn, or 18.2%, over the past year.

Key Rates and Spreads

Rates

  • 10-year Treasury bonds 3.95%, up +0.13 w/w (1-yr range: 1.66-4.25) (12 year high)
  • Credit spread 1.79%, down -0.09 w/w (1-yr range:1.76-2.42)
  • BAA corporate bond index 5.90%, up +016 w/w (1-yr range: 4.05-6.59) (10 year+ high)
  • 30-Year conventional mortgage rate 6.97%, up +0.09% w/w (1-yr range: 3.76-7.38) (new 20 year high)

Yield Curve

  • 10-year minus 2-year: -0.90%, up +0.04% w/w (1-yr range: -0.86 – 1.59) (new 40 year low)
  • 10-year minus 3-month: -0.91%, up +0.03% w/w (1-yr range: -1.17 – 2.04) (new low)
  • 2-year minus Fed funds: +0.28%, up +0.05% w/w.
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y)

10 Year Note Technical Analysis via KnovaWave

Highlights – Federal Reserve

  • Federal Reserve Credit declined $16.4bn last week to $8.332 TN.
  • Fed Credit was down $568bn from the June 22nd peak.
  • Over the past 181 weeks, Fed Credit expanded $4.606 TN, or 124%.
  • Fed Credit inflated $5.522 Trillion, or 196%, over the past 538 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt added $0.3bn last week to $3.353 TN.
  • “Custody holdings” were down $100bn, or 2.9%, y-o-y.

Rate markets market expectations are for peak Fed funds at 5.44% for the Fed’s September 20th meeting. This is around 40 bps higher than expectations in November.

Central Bank Watch – RBA, BoC, BoJ Rates; Federal Reserve Chair Powell Semi Annual Testimony

Highlights – Mortgage Market

  • Freddie Mac 30-year fixed mortgage rates increased eight bps to a four-month high 6.74% (up 298bps y-o-y).
  • Fifteen-year rates gained nine bps to 5.99% (up 298bps).
  • Five-year hybrid ARM rates jumped 14 bps to 5.97% (up 306bps).
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates up 20 bps to a 17-week high 7.17% (up 308bps).
Mortgage News Daily February 17, 2023
30-year Mortgage Rates Soar Back to November Highs of 6.62%, Mortgage Applications Fall 13.3%

Key Bond Auctions

Bond auctions this week: $40 bln 3-yr Treasury note auction results Tuesday, Wednesday the $32 bln 10-yr Treasury note reopening results at 13:00 ET; Thursday the $18 bln 30-yr Treasury bond auction results at 13:00 ET

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

German bund yields are currently about 40 bps higher than November levels. UK 10-year yields ended the week at 3.85%, up 85 bps over the past month to the high since the October crisis period. Spanish and Portuguese bond yields this week surpassed November peaks to trade at new multiyear highs (Spain back to 2014 and Portugal to 2017).

European high-yield (“crossover”) CDS fell 22 this week to 397 bps, down from 523 bps on November 9th (September high 695bps).

Emerging Market (EM) CDS dropped 15 this week to 229 bps. This compares to 276 bps on November 9th (September high 346bps).

Ten-year government yields down significantly to start the year.

  • Greek 10-year yields jumped nine bps to 4.46% (down 10bps y-o-y).
  • Italian yields rose nine bps to 4.53% (down 17bps).
  • Spain’s 10-year yields jumped 15 bps to 3.66% (up 15bps).
  • German bund yields surged 18 bps to 2.72% (up 27bps).
  • French yields jumped 18 bps to 3.20% (up 22bps).
  • The French to German 10-year bond spread was unchanged at 48 bps.
  • U.K. 10-year gilt yields surged 19 bps to 3.85% (up 18bps).

Where we got to in 2022:

Recession Fears Push German Yield Curve to Deepest Inversion Since 1992

Highlights – Asian Bonds

  • Japanese 10-year “JGB” yields were little changed at 0.50% (up 8bps y-t-d).

February 24 – Bloomberg (Toru Fujioka): “Bank of Japan Governor nominee Kazuo Ueda warned against any magical solution to produce stable inflation and normalize policy as he largely stuck to the existing central bank script in the first parliamentary hearing to approve his appointment… Ueda said the BOJ should continue with stimulus for now, while flagging the need to consider returning to a normal policy approach if the outlook for prices clearly improved. He said it would still take some time to reach stable and sustainable inflation in Japan… ‘If I’m appointed BOJ governor, my mission isn’t to come up with some kind of magical, special monetary policy,’ Ueda said. ‘As I’ve mentioned before, if you look at the trend in prices, there are improvements we’re seeing, but the situation remains that it’ll still take some time until we’ve securely achieved 2% inflation.’”

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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