Bond Traders Weekly Outlook: Higher for Longer Threatens Long Duration Portfolios

U.S. Treasuries in a volatile week saw the 5-yr note and shorter tenors reclaim some of their losses from Thursday after the stronger than expected ADP employment report was tempered by a much tamer BLS jobs report. However, the 10s and 30s added to this week’s losses. The 2-yr note recovered Thursday’s entire loss, continuing this week’s outperformance, which alleviated some pressure on the 2s10s spread, widening it by 17 bps to -89 bps. We get more volatility next week with the latest CPI report and Beige Book on the docket.

Crude oil bounced off its 50-day moving average (71.29), rising toward its June high (75.06). With the pullback in yields the U.S. Dollar Index fell 0.9% to 102.28 through its 50-day moving average (102.92), resulting in a 0.6% loss 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.

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 began Q3 with extreme volatility in the 2 and 10 years, most of it on Thursday and Friday. U.S. Treasuries in a volatile week saw the 5-yr note and shorter tenors reclaim some of their losses from Thursday after the stronger than expected ADP employment report was tempered by a much tamer BLS jobs report. However, the 10s and 30s added to this week’s losses. The 2-yr note recovered Thursday’s entire loss, continuing this week’s outperformance, which alleviated some pressure on the 2s10s spread, widening it by 17 bps to -89 bps. A reminder the 2s10s spread compressed by 31 bps in June and 49 bps in Q2.

Higher for longer is a serious threat

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.

  • The iShares Investment Grade Corporate ETF (LQD) declined 1.01% Thursday, the largest loss since May 1st. The 2.40% loss for the week was the largest since February.
  • The iShares High Yield ETF (HYG) declined 0.73% Thursday, also the largest decline since May 1st. The 1.63% loss for the week, the worst weekly performance since early-March.
  • Friday Bloomberg headlines: “HYG ETF Daily Outflows $1.13 Bln, Biggest Move Since March 28th.” and “Two Giant Credit ETFs Hit by $2 Billion Exit on Hawkish Fed Bets.”

Global Yields Spiking Higher

  • UK 10-year yields were up 16 bps Thursday to 5.54%, with two-year yields surging as much as 18 bps to a 15-year high 5.54%. Reminiscent of last fall, UK yields were pulling global yields higher – even before the jolt from the ADP report.
  • Italian 10-year yields surged 21 bps Thursday (4.37%),
  • Greek yields jumped 18 bps (3.97%).
  • Ten-year yields rose 17 bps in Spain (3.70%) and Portugal (3.36%).
  • Canadian 10-year yields surged 30 bps this week to an eight-month high of 3.57%.
  • Australian 10-year yields jumped 23 bps this week to 4.26% – the high since January 2014.
  • New Zealand yields rose 22 bps to 4.85% – the high since July 2011.

Emerging Market (EM) bond yields reversed sharply higher.

The EM bond ETF (EMB) dropped 1.43% Thursday and 2.25% for the week – the largest daily and weekly losses since February. Ominously for “carry trade” levered speculation, EM bond losses were compounded by an abrupt rally in the Japanese yen. This week’s 1.46%-yen gain versus the dollar was the biggest since December.

Local currency yields

  • Hungary rose 33 bps (7.33%)
  • South Africa rose 32 bps (12.07%)
  • Mexico rose 25 bps in Mexico (8.93%)

Dollar denominated EM debt

  • 25 bps in Chile (5.13%),
  • 25 bps in Indonesia (5.05%),
  • 25 bps in Colombia (8.26%),
  • 24 bps in the Philippines (5.00%),
  • 23 bps in Panama (6.04%),

Crude oil bounced off its 50-day moving average (71.29), rising toward its June high (75.06). With the pullback in yields the U.S. Dollar Index fell 0.9% to 102.28 through its 50-day moving average (102.92), resulting in a 0.6% loss for the week.

Yield Watch

Friday/Week

  • 2-yr: -7 bps to 4.94% (+6 bps for the week)
  • 3-yr: -6 bps to 4.65% (+16 bps for the week)
  • 5-yr: -3 bps to 4.34% (+21 bps for the week)
  • 10-yr: +1 bp to 4.05% (+23 bps for the week)
  • 30-yr: +3 bps to 4.03% (+17 bps for the week)

Key Rates and Spreads

Rates

  • 10-year Treasury bonds 4.06%, up +0.22% w/w (1-yr range: 2.60-4.25) (12 year high)
  • Credit spread 1.79%, down -0.14 w/w (1-yr range: 1.76-2.42)
  • BAA corporate bond index 5.85%, up +0.08% w/w (1-yr range: 5.00-6.59) (10 year+ high)
  • 30-Year conventional mortgage rate 7.14%, up +0.12% w/w (1-yr range: 5.05-7.38) (new 20 year high)

Yield Curve

  • 10-year minus 2-year: -0.87%, up +0.19% w/w (1-yr range: -1.06 – 1.59) (new 40 year low)
  • 10-year minus 3-month: -1.33%, up +0.13% w/w (1-yr range: -1.69 – 2.04) (new low)
  • 2-year minus Fed funds: -0.25%, down -0.08%
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y)
COT on bonds in week to July 3 showing the position breakdown between asset managers, dealer intermediaries and leveraged funds. The latter being the so-called fast group, as they tend to respond first to changes in the tech. and/or fund. outlook, holds an elevated short across the entire yield curve. Wweek to Monday July 3 (short week due to US holiday). @Ole_S_Hansen

Money Market Flows

Money fund assets have expanded an unprecedented $526 billion, or 51% annualized, over 12 weeks to a record $5.420 TN with one-year growth of $894 billion, or 19.7%. Such spectacular monetary inflation deserves serious contemplation.

  • Investment-grade bond funds posted inflows of $0.919 million, while junk bond funds reported outflows of $730 million (from Lipper).
  • Total money market fund assets slipped $3.0bn to $5.431 TN, but have posted a 16-week gain of $537bn (36% annualized). Total money funds were up $900bn, or 19.9%, y-o-y.
  • Total Commercial Paper jumped $20.2bn to $1.164 TN. CP was down $6bn, or 0.5%, over the past year.
The leveraged fund (Hedge funds, CTA’s etc.) position breakdown in 2’s and 10’s @Ole_S_Hansen

Bond auctions this week:

No auctions this week

Bond auctions week ahead:

  • Monday: 13- and 26-week bills
  • Tuesday: 52-week bills; 42-day CMB, $40 bln 3-yr Treasury note auction results at 13:00 ET
  • Wednesday: 17-week bills; $32 bln 10-yr Treasury note reopening results at 13:00 ET
  • Thursday: 4- and 8-week bills, 30-yr Treasury bond reopening results at 13:00 ET

10 Year Note Technical Analysis via KnovaWave

Highlights – Federal Reserve

  • Federal Reserve Credit declined $48.9bn last week to $8.269 TN.
  • Fed Credit was down $598bn from the June 22nd, 2022, peak.
  • Over the past 199 weeks, Fed Credit expanded $4.542 TN, or 122%.
  • Fed Credit inflated $5.458 TN, or 194%, over the past 556 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt slipped $0.6bn last week to $3.442 TN.
  • “Custody holdings” were up $55.1bn, or 1.6%, y-o-y.
Federal Reserve Leave Rates Unchanged as Expected. See 5.6% Fed Fund Rate at Year End
Central Bank Watch – Week Ahead Brings BOC, RBNZ, BOK and Fed Beige Book

Highlights – Mortgage Market

  • Freddie Mac 30-year fixed mortgage rates gained seven bps to 6.70% (up 100bps y-o-y).
  • Fifteen-year rates rose eight bps to 6.11% (up 128bps).
  • Five-year hybrid ARM rates increased 10 bps to 6.22% (up 172bps).
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates up 13 bps to 7.20% (up 142bps).
Mortgage News Daily

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

  • Greek 10-year yields gained seven bps to 3.65% (down 92bps y-t-d).
  • Italian yields rose nine bps to 4.07% (down 63bps).
  • Spain’s 10-year yields increased seven bps to 3.39% (down 13bps).
  • German bund yields gained four bps to 2.39% (down 5bps).
  • French yields rose five bps to 2.93% (down 5bps).
  • The French to German 10-year bond spread widened one to 54 bps.
  • U.K. 10-year gilt yields added another seven bps to 4.39% (up 72bps).

Gilts Sold Reminds Us of Risk.

  • UK 10-year yields were up 16 bps Thursday to 5.54%, with two-year yields surging as much as 18 bps to a 15-year high 5.54%. Reminiscent of last fall, UK yields were pulling global yields higher – even before the jolt from strong U.S. data.
  • Italian 10-year yields surged 21 bps Thursday (4.37%),
  • Greek yields jumped 18 bps (3.97%).
  • Ten-year yields rose 17 bps in Spain (3.70%) and Portugal (3.36%).
  • Canadian 10-year yields surged 30 bps this week to an eight-month high of 3.57%.
  • Australian 10-year yields jumped 23 bps this week to 4.26% – the high since January 2014.
  • New Zealand yields rose 22 bps to 4.85% – the high since July 2011.

The UK’s 10-year bond yields are the highest in the G7, as markets continue to worry about the extent of interest rate hikes that will be needed to bring inflation back under control. There was some nervousness in bond markets globally Thursday when British bond prices tumbled again on Thursday with concerns high inflation will force the Bank of England to carry on raising interest rates, with two-year gilts on track for one of the biggest weekly falls in 20 years.

Gilt yields were up on the day around 11 to 17 basis points (bps) over the range of maturities, adding to a similar jump on Wednesday as markets reeled from stronger-than-expected inflation data. Markets have repriced one more rate rise by the European Central Bank to 3.7 per cent from 3.5 per cent by October.

Highlights – Asian Bonds

  • Japanese 10-year “JGB” yields rose three bps to 0.40% (down 2bp 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)

Key US Bond Auction Highlights

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

US Producer Price Inflation Moderates Further in May, +1.1% versus +2.3% in April
Consumer Inflation in May Eases, Core CPI Stays Elevated as Real Earnings Fall
Robust Increase in Real Spending with Core PCE Inflation at Persistently High Levels in April
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, 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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