Bond Traders Weekly Outlook: Key 2s10s Treasury Spread Compressed 50% In Second Quarter

U.S. Treasuries closed out the second quarter with yields on the 10-yr note and shorter tenors near levels not seen since the first half of March. On Friday there was some support from The PCE Price Index growth rate slowed to a two-year low of 3.8% yr/yr from 4.3% in April while core PCE was up 4.6% yr/yr, down from 4.7% in April. This week’s action compressed the 2s10s spread by another five basis points, sending it to -106 bps. The 2s10s spread compressed by 31 bps in June and 49 bps in Q2. Treasuries completed this week’s note auctions with excellent demand for the $35 bln 7-yr note auction. We also completed a $43 bln 5-yr note auction and a $42 bln 2-yr note A rated auction.

Crude oil gained $1.47, or 2.1% this week and $2.52, or 3.7%, in June. The U.S. Dollar Index fell 0.4% to 102.92, trimming this week’s advance to 0.1%. The Index lost 1.3% in June.

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 closed Q2 mostly higher with yields on the 10-yr note and shorter tenors near levels not seen since the first half of March. The market received the Personal Income/Outlays report for May. The report showed an in-line 0.4% m/m increase in Personal Income while the April growth rate was revised down to 0.3% from 0.4%. Personal Spending (actual 0.1%; consensus 0.3%) was below expectations and the April growth rate was also revised down, to 0.6% from 0.8%. The PCE Price Index growth rate slowed to a two-year low of 3.8% yr/yr from 4.3% in April while core PCE was up 4.6% yr/yr, down from 4.7% in April.

The 2s10s spread compressed by another five basis points to -106 bps. The 2s10s spread compressed by 31 bps in June and 49 bps in Q2. Crude oil gained $1.47, or 2.1%, this week and $2.52, or 3.7%, in June. The U.S. Dollar Index fell 0.4% to 102.92 Friday pulling this week’s advance to 0.1%. The Index lost 1.3% in June.

Yield Watch

Friday/Week

  • 2-yr: UNCH at 4.88% (+13 bps for the week; +49 bps in June; +82 bps in Q2)
  • 3-yr: -2 bps to 4.49% (+16 bps for the week; +45 bps in June; +66 bps in Q2)
  • 5-yr: -1 bp to 4.13% (+13 bps for the week; +39 bps in June; +52 bps in Q2)
  • 10-yr: -4 bps to 3.82% (+8 bps for the week; +18 bps in June; +33 bps in Q2)
  • 30-yr: -6 bps to 3.86% (+4 bps for the week; UNCH in June; +17 bps in Q2)

Key Rates and Spreads

Rates

  • 10-year Treasury bonds 3.74%, down -0.03% w/w (1-yr range: 2.60-4.25) (12 year high)
  • Credit spread 2.00%, up +0.03 w/w (1-yr range: 1.76-2.42)
  • BAA corporate bond index 5.74%, unchanged w/w (1-yr range: 5.00-6.59) (10 year+ high)
  • 30-Year conventional mortgage rate 6.94%, up +0.04% w/w (1-yr range: 5.05-7.38) (new 20 year high)
  • (NB From Last Week due to holiday)

Yield Curve

  • 10-year minus 2-year: -1.01%, down -0.06% w/w (1-yr range: -1.01 – 1.59) (new 40 year low)
  • 10-year minus 3-month: -1.56%, down -0.10% w/w (1-yr range: -1.69 – 2.04) (new low)
  • 2-year minus Fed funds: -0.32%, up +0.03%
  • (NB From Last Week due to holiday)
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y)
COT on bonds in week to June 20 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 @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:

  • Strong International Demand in 7-year Treasury Bond Auction Completes Week’s Solid Offerings
Strong International Demand in 7-year Treasury Bond Auction Completes Week’s Solid Offerings
  • Softer Demand in 5-Year Treasury Auction Follows Yesterday’s Strong 2-Year
Softer Demand in 5-Year Treasury Auction Follows Yesterday’s Strong 2-Year
  • International Buyers Soak Up 2-year Treasury Bonds as 2/10 Inversion Breaks 100 Bps
International Buyers Soak Up 2-year Treasury Bonds as 2/10 Inversion Breaks 100 Bps

10 Year Note Technical Analysis via KnovaWave

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.

Highlights – Federal Reserve

  • Federal Reserve Credit declined $17.2bn last week to $8.318 TN.
  • Fed Credit was down $583bn from the June 22nd, 2022, peak.
  • Over the past 198 weeks, Fed Credit expanded $4.591TN, or 123%.
  • Fed Credit inflated $5.507 TN, or 196%, over the past 555 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt rose $7.0bn last week to $3.432 TN.
  • “Custody holdings” were up $42bn, or 1.2%, y-o-y.
Federal Reserve Leave Rates Unchanged as Expected. See 5.6% Fed Fund Rate at Year End
Central Bank Watch – Banker Torment, SNB, Norges Bank, Turkey and BOE all Raised Rates

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 two-year yields spiked 40 bps 2 weeks ago to 4.93% (2-wk gain 58bps) – surpassing late-September crisis levels to the highest yield since the summer of 2008.
  • Two-year yields were up that week 20 bps in Sweden, 21 bps in Germany, 20 bps in France, and 16 bps in Italy.
  • Australian two-year yields jumped 20 bps this week to 4.20% – to the high since the summer of 2011.

The prior week saw the yield on UK two-year debt rose 0.6 percentage points week to over 4.5 per cent, its highest level since October. The equivalent German bond yield rose from 2.5 per cent early this month to just under 3 per cent.

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

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