Bond Traders Weekly Outlook: CPI and FOMC on Deck

U.S. Treasuries were lower after a choppy week with longer tenors leading the pullback after outperforming earlier in the week.  The 2s10s spread ended the week at -77 bps, one basis point wider from last week’s settlement. What caused the angst? US reports that questioned a less hawkish tone from the fed at next week’s FOMC. Friday, we had a PPI hotter than expectations ahead of next week’s Consumer Price Index We also had an above-consensus preliminary reading of the University of Michigan’s Consumer sentiment survey for December. 

Hungry Bond Traders

Weekly Recap

Earlier in the week we had heard the ISM Non-Manufacturing Index for November increased to 56.5%, well ahead of a consensus 53.5% and up from 54.4% in October. The report follows the strong November jobs report released Friday indicating the economy is still hotter than the Federal Reserve would like at this time. US factory orders for manufactured goods rose 1.0% month-over-month in October higher than the consensus 0.7% and following an unrevised 0.3% increase in September.

The coming FOMC meeting will also include an updated Summary of Economic Projections that will provide some insight on terminal rate projections. The market is well aware and longer-dated Treasuries had a more noticeable reaction to the data Friday. The 10-yr note yield rose eight basis points to 3.57%, the 2-yr note yield, rose by two basis points to 4.34%. 

Yield Watch

  • 2-yr: +2 bps to 4.34% (+5 bps for the week)
  • 3-yr: +2 bps to 4.07% (+6 bps for the week)
  • 5-yr: +5 bps to 3.76% (+9 bps for the week)
  • 10-yr: +8 bps to 3.57% (+6 bps for the week)
  • 30-yr: +9 bps to 3.55% (-1 bp for the week)

Investment-grade bond funds posted inflows of $1.196 billion, and junk bond funds reported positive flows of $66 million (from Lipper).

Key Rates and Spreads

Rates

  • 10-year Treasury bonds 3.59%, up +0.11 w/w (1-yr range: 1.08-4.22) (12 year high)
  • Credit spread 1.80%, down -0.55 w/w (1-yr range: 1.65-4.31)
  • BAA corporate bond index 5.39%, down -0.44 w/w (1-yr range: 3.13-6.59) (10 year+ high)
  • 30-Year conventional mortgage rate 6.32%, down -0.02% w/w (1-yr range: 2.75-7.38) (new 20 year high)

Yield Curve

  • 10-year minus 2-year: -0.85%, down -0.06% w/w (1-yr range: -0.85 – 1.59) (new 40 year low)
  • 10-year minus 3-month: -0.72%, down -0.22% w/w (1-yr range: -0.37 – 2.04) (new low)
  • 2-year minus Fed funds: +0.51%, up +0.07% w/w
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y)

10 Year Note Technical Analysis via KnovaWave

Key Bond Auctions

Highlights – Mortgage Market

  • Freddie Mac 30-year fixed mortgage rates dropped 11 bps to a three-month low 6.28% (up 318bps y-o-y).
  • Fifteen-year rates fell 11 bps to 5.68% (up 330bps).
  • Five-year hybrid ARM rates slipped two bps to 5.47% (up 302bps).
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates up 14 bps to 6.63% (up 338bps).
Mortgage News Daily November 4, 2022

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)

Highlights – European Bonds

  • Greek 10-year yields rose 10 bps to 3.98% (up 266bps y-t-d).
  • Italian yields gained seven bps to 3.84% (up 267bps).
  • Spain’s 10-year yields increased eight bps to 2.96% (up 239bps).
  • German bund yields rose eight bps to 1.93% (up 211bps).
  • French yields gained nine bps to 2.40% (up 220bps).
  • The French to German 10-year bond spread widened about one to 47 bps.
  • U.K. 10-year gilt yields added three bps to 3.18% (up 221bps).

Highlights – Asian Bonds

  • Japanese 10-year “JGB” yields were little changed at 0.26% (up 19bps y-t-d).

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.

Highlights – Federal Reserve

  • Federal Reserve Credit declined $22.6bn last week to $8.546 TN. Fed Credit was down $354bn from the June 22nd peak.
  • Over the past 169 weeks, Fed Credit expanded $4.820 TN, or 129%.
  • Fed Credit inflated $5.736 Trillion, or 204%, over the past 526 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt last week fell $5.5bn to $3.307 TN – the low since June 2017.
  • “Custody holdings” were down $139bn, or 4.0%, y-o-y.
  • Total money market fund assets jumped $47.7bn to $4.718 TN – the high since June 2020. Total money funds were up $82.4bn, or 1.8%, y-o-y.
  • Total Commercial Paper surged $24.8bn to $1.318 TN – the high since November 2009. CP was up $229bn, or 21.0%, over the past year.

Federal Reserve Gives All Banks a Pass in Annual Bank Stress Test

The Federal Reserve released its annual bank stress test after the market last quarter. All 34 large banks tested remained well above their risk-based minimum capital requirements, and the Fed announced no restrictions relating to dividends and buybacks. With the dismal state of the economy through soaring inflation and record low consumer sentiment these tests were keenly watched. Banks suffered slightly more hypothetical losses in the 2022 severe test than last year, posting $612 billion in projected losses as capital ratios fell to 9.7%. Read More Here.


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