Rates React to Fed and Strong Jobs – Bond Market Review

U.S. Treasuries closed out the week on a sharply lower note, yields coming their lowest levels of the year after the red-hot January jobs report showed headline growth of 353,000, twice as high consensus. The report fed the rationale that the Fed will maintain its hawkish rhetoric. Notably Chicago Fed President Goolsbee said that the report will not influence policy in the near term, noting that the drop in the average workweek to 34.1 hours from 34.3 hours reflected weakness below the strong surface. Another volatile week for the notably unstable benchmark MBS yields. They were down as much as 33 bps at Thursday’s low, only for yields to reverse 26 bps higher in Friday trading to end the week a basis point lower at 5.50%.

Hungry Bond Traders

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.

Weekly Recap

U.S. Treasuries closed out the week on a sharply lower note, yields coming their lowest levels of the year after the red-hot January jobs report showed headline growth of 353,000, twice as high consensus. The report fed the rationale that the Fed will maintain its hawkish rhetoric. Notably Chicago Fed President Goolsbee said that the report will not influence policy in the near term, noting that the drop in the average workweek to 34.1 hours from 34.3 hours reflected weakness below the strong surface.

Another volatile week for the notably unstable benchmark MBS yields. They were down as much as 33 bps at Thursday’s low, only for yields to reverse 26 bps higher in Friday trading to end the week a basis point lower at 5.50%.

Ten-year yields rose 14 bps, partially reversing earlier declines to end the week down 12 bps at 4.02%. Two-year Treasury yields jumped 16 bps Friday to 4.36%. The 10-yr yield, meanwhile, stopped just below the 50-day moving average of 4.083%. This week’s outperformance in longer tenors put renewed pressure on the 2s10s spread, compressing it by 15 bps since last Friday to -35 bps.

Crude oil fell back below its 50-day moving average (73.55) to its lowest level in more two weeks while the U.S. Dollar Index climbed 0.9% to 103.93, bouncing off its 50-day moving average (102.89) past its 200-day moving average (103.54) to a level not seen in more than seven weeks. The Index gained 0.4% for the week.

Earlier in the week the Treasury Department’s first quarter borrowing estimate was to borrow $760 billion in Q1, which is $55 billion below the forecast from October due to higher net fiscal flows and a higher cash balance at the beginning of the quarter. Borrowing in Q2 is expected to reach $202 billion.

The fed funds futures market repriced the probability of a 25-basis points rate cut at the March FOMC meeting to 20.5% (from 38.0% Thursday and 47.6% one week ago) while the probability of a 25-basis points rate cut at the May FOMC meeting has been reduced to 74% (from 93.8% yesterday), according to the CME FedWatch Tool. The policy rate is expected to decline 24 and 46 bps by the May 1st and June 12th FOMC meetings. The market is pricing a 4.07% rate (126 bps of cuts) by the December 18th meeting, rising only eight bps this week.

Reminder Dollar Denominated EM Debt Market says Caution.

With all the geopolitical angst we are seeing warning signs of global de-risking/deleveraging and associated liquidity issues with that.

  • UK 10-year yields jumped 17 bps Friday.
  • Yields were up near double-digits in Canada, France, Germany, Italy, Spain, Netherlands, Poland, Hungary, Turkey, Denmark, and Ireland.
  • Local currency yields were 32 bps higher in Colombia and 21 bps higher in Mexico.
  • Dollar-denominated yields were up 17 bps in Panama, 14 bps in Peru, 14 bps in Mexico and 14 bps in Chile.

Food for thought, what would a 2024 global yield spike do? We have multiple global flashpoints with clear inflation ramifications and risks. Stay alert to possible bifurcations, global disasters can also lead to deflation and global trade destruction.

Yield Watch

Friday/Week

  • 2-yr: +19 bps to 4.38% (-2 bps for the week)
  • 3-yr: +17 bps to 4.14% (-3 bps for the week)
  • 5-yr: +19 bps to 3.99% (-7 bps for the week)
  • 10-yr: +17 bps to 4.03% (-13 bps for the week)
  • 30-yr: +12 bps to 4.23% (-16 bps for the week)

Key Rates and Spreads

Rates

  • 10-year Treasury bonds 4.03%, down -0.11% w/w (1-yr range: 3.30-4.99) (new 15 year high 10/20/23 w/e)
  • Credit spread 1.47%, down -0.13% w/w (1-yr range: 1.36-2.42) (new 1 year low 1/19/24 w/e)
  • BAA corporate bond index 5.50%, down -0.24% w/w (1-yr range: 5.28-6.80) (14 year+ high w/w 10/20/23)
  • 30-Year conventional mortgage rate 6.92%, up +0.02% w/w (1-yr range: 5.99-8.03) (new 23 year high 10/20/23 w/e)

Yield Curve

  • 10-year minus 2-year: -0.34%, down -0.13% w/w (1-yr range: (-1.07 – -0.17) (new 40 year low)
  • 10-year minus 3-month: -1.35%, down -0.13% w/w (1-yr range: -1.89 – 0.21)
  • 2-year minus Fed funds: -0.96%, up +0.01% w/w
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y)

Money Market Flows

  • Total money market fund assets jumped $42bn to a record $6.001 TN.
  • Money funds were up $1.181 TN, or 24.5%, y-o-y.
  • Total Commercial Paper jumped $14.3bn to $1.266 TN. CP was down $24.6bn, or 1.9%, over the past year.

Bond auctions this week:

Bond auctions week ahead:

Next week will bring some new supply.

  • Monday: $79 billion 13-week bills, $70 billion 26-week bills
  • Tuesday: $80 billion 42-day cash management bills, $54 bln 3-yr Treasury note auction results at 13:00 ET
  • Wednesday: $56 billion 17-week bills, $42 bln 10-yr Treasury note auction results at 13:00 ET;
  • Thursday: $80 billion 4- and 8-week bills, $25 bln 30-yr Treasury bond auction results at 13:00 ET

Source: UST Upcoming Auctions

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.

Recap: 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.

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

Highlights – Federal Reserve

  • Federal Reserve Credit declined $20.2bn last week to $7.619 TN.
  • Fed Credit was down $1.271 TN from the June 22nd, 2022, peak.
  • Over the past 229 weeks, Fed Credit expanded $3.892 TN, or 104%.
  • Fed Credit inflated $4.808 TN, or 171%, over the past 586 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt dropped another $12.7bn last week to a nine-month low $3.344 TN.
  • “Custody holdings” were up $19.4bn, or 0.6%, y-o-y.

Powell at the FOMC:

Powell: “Our strong actions have moved our policy rate well into restrictive territory, and we have been seeing the effects on economic activity and inflation… We believe that our policy rate is likely at its peak for this tightening cycle and that, if the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year.”

Chair Powell: “I’m not so worried about that. Again, we’ve had inflation come down without a slow economy and without important increases in unemployment, and there’s no reason why we should want to get in the way of that process if it’s going to continue. So, I think declining inflation – continued declines in inflation – are really the main thing we’re looking at. Of course, we want the labor market to remain strong, too. We don’t have a growth mandate. We’ve got a maximum employment mandate and a price stability mandate, and those are the two things we look at. Growth only matters to the extent it influences our achievement of those two mandates.”

Powell: “So, I guess I would just say this: executive summary would be that growth is solid to strong over the course of last year. The labor market, 3.7% unemployment indicates that the labor market is strong. We’ve had just about two years now of unemployment under 4%. That hasn’t happened in 50 years. So, it’s a good labor market. And we’ve seen inflation come down… The outlook, we do expect growth to moderate. Of course, we have expected it for some time, and it hasn’t happened. But we do expect that it will moderate as supply chain and labor market normalization runs its course.”

Powell: “In terms of growth, we’ve had strong growth. If you take a step back, we’ve had strong growth, very strong growth last year, going right into the fourth quarter. And yet, we’ve had a very strong labor market, and we’ve had inflation coming down. So, I think, whereas a year ago, we were thinking that we needed to see some softening in economic activity, that hasn’t been the case. So, I think we look at stronger growth, we don’t look at it as a problem. I think, at this point, we want to see strong growth. We want to see a strong labor market. We’re not looking for a weaker labor market. We’re looking for inflation to continue to come down, as it has been coming down for the last six months.”

Highlights – Mortgage Market (Prior Week)

  • Freddie Mac 30-year fixed mortgage rates declined six bps to 6.63% (up 64bps y-o-y).
  • Fifteen-year rates dipped two bps to 5.94% (up 76bps).
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates down seven bps to a six-month low 6.95% (up 63bps).
Mortgage News Daily

Major Benchmark 10-year Bond markets

Highlights – European Bonds

  • Italian yields dipped one basis point to 3.82% (up 12bps y-t-d).
  • Greek 10-year yields slipped one basis point to 3.30% (up 25bps).
  • Spain’s 10-year yields declined three bps to 3.17% (up 18bps).
  • German bund yields fell six bps to 2.24% (up 22bps).
  • French yields declined five bps to 2.75% (up 19bps).
  • The French to German 10-year bond spread widened one to 50 bps.
  • U.K. 10-year gilt yields fell five bps to 3.92% (up 38bps).

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 declined four bps to 0.67% (up 6bps y-t-d).

Key US Bond Auction Highlights 2024

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.


Bond Market Performance 2023

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Sources: Scotia Bank, TC, FT

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