Bond Traders Weekly Outlook: Higher Yields Attracting Record Inflows into US Treasuries

Another vicious week for bond markets with Treasuries lower for the third week in a row as yields continued to rise. We also saw Moody’s downgrade regional banks following on from Fitch lowering U.S. debt from AAA to AA+. The higher yields have seen US Treasuries on course for a record year of inflows according to Bank of America. U.S. Treasuries belly led the market lower after the release of a hotter than expected PPI report for July on Friday. The report followed a lower-than-expected CPI report the day before. This week’s action had no impact on the 2s10s spread, which remained at -72 bps, but the 5s30s spread inverted again, ending the week at -4 bps.

Crude oil closed the week at $83.20/bbl, just below its highest level since mid-November, the U.S. Dollar Index climbed 0.3% to 102.85, extending this week’s gain to 0.8%.

Hungry Bond Traders

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.

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

Another vicious week for bond markets with Treasuries lower for the third week in a row as yields continued to rise. We also saw Moody’s downgrade regional banks following on from Fitch lowering U.S. debt from AAA to AA+. U.S. Treasuries belly led the market lower after the release of a hotter than expected PPI report for July on Friday. The report followed a lower-than-expected CPI report the day before.

Ten-year Treasury yields rose another five bps Friday, pushing the week’s gain to 12 bps (to 4.15%). Ten-year yields are again threatening the 4.24% spike high from last October. Benchmark MBS’s 11 bps Friday jump boosted the week’s yield gain to a notable 23 bps. MBS yields traded above 6% intraday Friday (closed at 5.97%), again nearing the 6.10% October high.

This week’s action had no impact on the 2s10s spread, which remained at -72 bps, but the 5s30s spread inverted again, ending the week at -4 bps.

August 11 – Bloomberg (Farah Elbahrawy and Greg Ritchie): “US Treasuries are on course for a record year of inflows as investors chasing some of the highest yields in months pile into cash and bonds, according to Bank of America… Cash funds attracted $20.5 billion and investors poured $6.9 billion into bonds in the week through August 9… Meanwhile, US stocks had their first outflow in three weeks at $1.6 billion. Flows into Treasuries have reached $127 billion this year, set for an annualized record of $206 billion, BofA said.”

Benchmark MBS yields traded above 6% in early-Friday trading for the first time since the (UK bond dislocation) October yield spike. MBS yields reversed a notable 26 bps in volatile Friday trading, ending the week up six bps to 5.74%. Long-bond yields surged a notable 19 bps this week to 4.20% (high since November).

Yield Watch

Friday/Week

  • 2-yr: +6 bps to 4.89% (+11 bps for the week)
  • 3-yr: +8 bps to 4.56% (+9 bps for the week)
  • 5-yr: +11 bps to 4.31% (+15 bps for the week)
  • 10-yr: +9 bps to 4.17% (+11 bps for the week)
  • 30-yr: +3 bps to 4.27% (+6 bps for the week)

Key Rates and Spreads

Rates

  • 10-year Treasury bonds 4.17%, up +.09% w/w (1-yr range: 2.60-4.25) (12 year high)
  • Credit spread 1.87%, down -.09% w/w (1-yr range: 1.76-2.42)
  • BAA corporate bond index 6.04%, up +.25% w/w (1-yr range: 5.00-6.59) (10 year+ high)
  • 30-Year conventional mortgage rate 7.11%, down -0.01% w/w (1-yr range: 5.05-7.38) (new 20 year high)

Yield Curve

  • 10-year minus 2-year: -0.73%, unchanged w/w (1-yr range: -1.06 – 1.59) (new 40 year low)
  • 10-year minus 3-month: -1.26%, down -0.13% w/w (1-yr range: -1.69 – 2.04) (new low)
  • 2-year minus Fed funds: -0.43%, down -0.13% w/w.
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y)

Money Market Flows

  • Investment-grade bond funds posted inflows of $217 million, and junk bond funds reported outflows of $282 million (from Lipper).
  • Total money market fund assets gained $14.4bn to a record $5.530 TN, with a 22-week gain of $636bn (31% annualized). Total money funds were up $963bn, or 21.1%, y-o-y.
  • Total Commercial Paper increased $5.8bn to $1.172 TN. CP was down $5.2bn, or 0.4%, over the past year.

COT on bonds Aug 11: Leveraged funds-maintained a near record short across the US yield curve in the wk to Aug 8 when the curve steepened with 2’s down 15 bps and 30’s up 11 bps. Especially the bearish long-end exposure remains extreme with the combined DV01 (value of one bp yield change) on T-Bond and T-Bond Ultra above 140m dollars. @Ole_S_Hansen

Bond auctions this week:

Bond auctions week ahead:

Next week will bring some new supply.

  • Monday: 13- and 26-week bills,
  • Tuesday: 52-week bills; 42-day CMB,
  • Wednesday: 17-week bills;
  • Thursday: 4- and 8-week bills,

10 Year Note Technical Analysis via KnovaWave

Highlights – Federal Reserve

  • Federal Reserve Credit declined $18.7bn last week to $8.171 TN.
  • Fed Credit was down $729bn from the June 22nd, 2022, peak.
  • Over the past 204 weeks, Fed Credit expanded $4.445 TN, or 119%.
  • Fed Credit inflated $5.361 TN, or 191%, over the past 561 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt gained $8.7bn last week to $3.454 TN.
  • “Custody holdings” were up $76.2bn, or 2.3%, y-o-y.

Powell at the FOMC: “The federal-funds rate is at a restrictive level now. So, if we see inflation coming down credibly, sustainably, then we don’t need to be at a restrictive level anymore. We can move back to a neutral level and then below a neutral level at a certain point… And you’d start cutting before you got to 2% inflation too. Because we don’t see ourselves getting to 2% inflation until—you know, all the way back to 2 until 2025 or so.”

Highlights – Mortgage Market

  • Freddie Mac 30-year fixed mortgage rates added three bps to an eight-month high 6.95% (up 173bps y-o-y).
  • Fifteen-year rates rose eight bps to 6.39% (up 180bps).
  • Five-year hybrid ARM rates surged 27 bps to 6.78% (up 235bps) – to the high in data back to 2003.
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates up two bps to 7.73% (up 190bps).
Mortgage News Daily

Global Bond Watch

Higher for longer is a serious threat.

Global Yields Spiking Higher

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.

Emerging Market (EM) bond yields reversed sharply higher.

Following the increased funding needs and Firch downgrade the move higher in US yields saw “risk off” extended to the emerging markets. EM currencies quickly under pressure with global risk aversion. Even after Friday’s rally, the week’s losses were meaningful.

  • South African rand declined 4.5%,
  • Russian ruble 3.9%,
  • Colombian peso 3.7%,
  • Brazilian real 2.9%,
  • Chilean peso 2.7%,
  • South Korean won 2.5%,
  • Peruvian sol 2.4%.
  • Mexican peso’s 1.4% Friday advance cut losses for the week to 2.3%.

Dollar denominated EM debt surged higher

  • 23 bps in Panama (to 6.02%),
  • 22 bps in Turkey (8.13%),
  • 20 bps in the Philippines (4.95%),
  • 20 bps in Brazil (6.07%)
  • 19 bps in Indonesia (5.01%),
  • 18 bps in Peru (5.33%).
  • 16 bps in Mexico (5.62%).

Local currency yields

  • 29 bps in Colombia (10.41%),
  • 25 bps in Romania (6.70%),
  • 21 bps in Hungary (7.42%),
  • 19 bps in Mexico (8.99%),
  • 17 bps in Peru (6.89%).

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.

Major Benchmark 10-year Bond markets

Bond Market Performance 2023

Major 10-year Bonds/Notes

Highlights – European Bonds

  • Greek 10-year yields jumped 11 bps to 3.89% (down 68bps y-t-d).
  • Italian yields gained four bps to 4.25% (down 45bps).
  • Spain’s 10-year yields rose four bps to 3.64% (up 12bps).
  • German bund yields gained six bps to 2.62% (up 18bps).
  • French yields rose six bps to 3.15% (up 17bps).
  • The French to German 10-year bond spread was little changed at 53 bps.
  • U.K. 10-year gilt yields jumped 15 bps to 4.53% (up 86bps).

Gilts Sold Reminds of Risk.

(We keep this as a reminder so events like Fitch’s downgrade of the US are not a Suprise)

Post ADP, Pre-June CPI/PPI Dropped:

  • 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.

Highlights – Asian Bonds

  • Japanese 10-year “JGB” yields dropped eight bps to 0.58% (up 16bps y-t-d).

The Bank of Japan and its new Governor felt compelled to do, so, it tinkered with YCC (yield curve control), cleverly achieving some flexibility without unleashing a panic. Ueda adjusting a policy after signaling no move would be forthcoming left the markets feeling ‘betrayed’. There was a leak the day before the meeting. Ueda stated the YCC tweak “didn’t represent a step toward normalization” and the “BOJ still sees a long way to achieving price goal.” Ah, huh … the market sighed collectively.

July 28 – Financial Times (Kana Inagaki, Leo Lewis and Hudson Lockett): “The Bank of Japan has eased controls on its government bond market, altering a cornerstone of its ultra-loose monetary policy and prompting a surge in the country’s benchmark bond yields to the highest level in nine years. In an unexpected move, the BoJ said it would offer to buy 10-year Japanese government bonds at 1% in fixed-rate operations, in effect widening the trading band on long-term yields. The central bank added that it was technically maintaining its previous 0.5% cap on 10-year bond yields, but this level would be a ‘reference’ rather than a ‘rigid limit’. The move triggered confusion about whether the central bank would make further moves to unwind its easing policy, which has come under pressure this year from inflation that has hit four-decade highs. But the BoJ held its overnight rate at minus 0.1%, saying more time was needed to sustainably achieve its 2% inflation target.”

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

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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