Bond Traders Weekly Outlook: Flipping Between End of Inflation and Hawkish Fed Trades

U.S. Treasuries fell further Friday, widening this week’s losses in all tenors. Treasury yields responding to an increase in year-ahead inflation expectations seen in the preliminary University of Michigan Consumer Sentiment Index for April and Fed Governor Waller (FOMC voter) saying that the central bank has not made much progress on inflation. Fed Rate hike expectations climbed today, with the implied likelihood of a 25-bps increase on May 3 rising to 74.5% from 67.0% yesterday and 71.2% a week ago. The U.S. Dollar Index climbed 0.5% to 101.56.

We had three lackluster Treasury reopening’s this week, 30-yr bond reopening was rated a C+ after Thursday D rated 10-year auction and Tuesday’s 3 Year sale drawing a C+ also.

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

The 2-yr note yield rose 11 basis points to 4.10% and the 10-yr note yield rose seven basis points to 3.52% on Friday.

The Retail Sales report for March was also released Friday, was lower than forecast with a softening in consumer spending. However, there was an upward revision to last month’s reading.

Friday also featured the release of quarterly results from several major banks with Citigroup (C), PNC (PNC), JPMorgan Chase (JPM), and Wells Fargo (WFC) beating their respective estimates. JPMorgan Chase CEO Dimon addressed lending conditions becoming more challenging, adding that there is no “credit crunch.” BlackRock (BLK) also reported, and CEO Fink said that he expects rates to stay higher for longer due to stubborn inflation.

For bond traders the big question is the U.S. bank lending boom still intact after the collapse of lending from the regional bank bankruptcies’, or has the Bubble been pierced? These coming weeks bank earnings conference calls will be insightful as will the response of the economy to the huge inflow from the Fed in the past month. Simply, a bubble maintaining an inflationary bias will demonstrate a powerful response to stimulus. The flipside is if the bubble deflates, it will develop increasing resistance to stimulus measures. Was the past month a big enough shock to ‘restart’ the stimulus process?

Money market fund assets surged $384 billion over the past five weeks to a record $5.277 TN, with year-to-date growth of $463 billion, or 42% annualized. In the 15 months leading up to the GFC (June 2007 to September 2008), money fund assets surged $1.055 TN, or 42%.

  • Investment-grade bond funds posted inflows of $1.129 billion, and junk bond funds reported positive flows of $235 million (from Lipper).
  • Total money market fund assets jumped $30.3bn to a record $5.277 TN, with a five-week gain of $384 billion. Total money funds were up $718bn, or 15.7%, y-o-y.
  • Total Commercial Paper gained $11.5bn to $1.146 TN. CP was up $76bn, or 7.1%, over the past year

Bond auctions last week:

Solid Demand at US 30-year Treasury Bond Auction Following CPI and PPI Data
Weak Demand in 10-year U.S. Treasury Bond Auction Following CPI Report
Steady 3-Year Treasury Bond Auction with High yield 3.810% Right on When Issued Pricing

Yield Watch

Friday/Week

  • 2-yr: +11 bps to 4.10% (+14 bps for the week)
  • 3-yr: +13 bps to 3.84% (+9 bps for the week)
  • 5-yr: +10 bps to 3.61% (+11 bps for the week)
  • 10-yr: +7 bps to 3.52% (+12 bps for the week)
  • 30-yr: +5 bps to 3.74% (+12 bps for the week)

Key Rates and Spreads

Rates

  • 10-year Treasury bonds 3.52%, up +0.11 w/w (1-yr range: 1.66-4.25) (12 year high)
  • Credit spread 2.00%, down -0.03 w/w (1-yr range: 1.76-2.42)
  • BAA corporate bond index 5.52%, up +0.08 w/w (1-yr range: 4.31-6.59) (10 year+ high)
  • 30-Year conventional mortgage rate 6.50%, up +0.32% w/w (1-yr range: 5.05-7.38) (new 20 year high)

Yield Curve

  • 10-year minus 2-year: -0.58%, unchanged w/w (1-yr range: -0.86 – 1.59) (new 40 year low)
  • 10-year minus 3-month: -1.48%, up +0.04% w/w (1-yr range: -1.17 – 2.04) (new low)
  • 2-year minus Fed funds: -0.73%, up +0.11% w/w.

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.
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y)

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 $12.7bn last week to $8.586. TN.
  • Fed Credit was down $281bn from the June 22nd peak.
  • Over the past 186 weeks, Fed Credit expanded $4.860 TN, or 130%.
  • Fed Credit inflated $5.776 Trillion, or 205%, over the past 544 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt gained $11.7bn last week to $3.331 TN.
  • “Custody holdings” were down $130bn, or 3.8%, y-o-y.

It’s been four weeks since the implosion of three US banks, Silicon Valley Bank, Signature Bank and Silvergate Capital Corp. From there we saw further selling of Credit Suisse that has never recovered from Archegos and the panic selling and speculative attacks on other US Regional banks. The Federal Reserve has worked in concert with the Treasury and major money center banks to stabilize conditions. The speed of protective measures for the financial system has been impressive but with that longer-run moral hazard problems and adverse incentives are front and center.

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 gained eight bps to 6.34% (up 134bps y-o-y).
  • Fifteen-year rates rose eight bps to 5.61% (up 144bps).
  • Five-year hybrid ARM rates jumped 16 bps to 5.71% (up 202bps).
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates up 11 bps to 6.86% (up 185bps).
Mortgage News Daily February 17, 2023

Key Bond Auctions

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 surged 21 bps to 4.28% (down 28bps y-o-y).
  • Italian yields jumped 27 bps to 4.30% (down 40bps).
  • Spain’s 10-year yields rose 25 bps to 3.48% (down 4bps).
  • German bund yields surged 26 bps to 2.44% (unchanged).
  • French yields jumped 31 bps to 3.01% (up 3bps).
  • The French to German 10-year bond spread widened five to 57 bps.
  • U.K. 10-year gilt yields rose 24 bps to 3.67% (down 1bp).

This all happened quickly…. just weeks 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 added a basis point to 0.48% (up 5bps 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)
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.’”

Inflation, Disinflation

FAO World Food Price Index Fell in March for Twelfth Consecutive Month
US Core PCE Inflation Comes in Lighter Than Expected in February
US Producer Price Inflation Fell in February as Economy Faces Headwinds
Modest Pullback in US Consumer Inflation in February as Core Services Prices Climb
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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Sources: Scotia Bank, TC

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