Bond Traders Weekly Outlook: Long End Adjusting to Rising Inflation and Increased Funding Needs

It was vicious week for bond markets this past week as yields continued to rise and then saw bust out moves after Fitch lowered U.S. debt from AAA to AA+. U.S. Treasuries finished the week rallying after the July jobs report. Ten-year Treasury yields rose 8bps for the week to 4.03%, after trading up to 4.20% Friday following the release of July payroll data. This was within two bps of the October 21st high, which was the peak yield back to June 2008. The 5-yr note and shorter tenors went positive for the week while 10s and 30s trimmed their losses from the past three days.

The jobs report showed continued moderation in payroll growth and contained downward revisions from the past two months. However average hourly earnings continued increasing at an expected pace suggested the Fed’s higher for longer stance. Pressure came off the 2s10s spread, which expanded by 21 bps to -72 bps. The 5s30s spread returned into positive territory for the first time since mid-June. Long end adjusted to rising inflation expectations and increased funding needs.

Hungry Bond Traders

The strong data and inflation falling is buoying the view that the economy will avoid a hard landing and that the Fed is close to being done raising interest rates. Crude oil rose $2.24, or 2.8%, to its highest level since mid-April while the U.S. Dollar Index fell 0.5% to 102.02, slipping back below its 50-day moving average (102.38). The Index gained 0.4% for the week.

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

It was vicious week for bond markets this past week as yields continued to rise and then saw bust out moves after Fitch lowered U.S. debt from AAA to AA+. U.S. Treasuries finished the week rallying after the July jobs report. The 5-yr note and shorter tenors went positive for the week while 10s and 30s trimmed their losses from the past three days. The report showed continued moderation in payroll growth and contained downward revisions from the past two months. However average hourly earnings continued increasing at an expected pace suggested the Fed’s higher for longer stance.

U.S. Adds 187,000 Jobs in July, Unemployment Rate Fell to 3.5%

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).

Fitch Downgrades United States Long-Term Ratings to ‘AA+’ from ‘AAA’, Outlook Stable

We saw pressure off the 2s10s spread, which expanded by 21 bps to -72 bps. The 5s30s spread returned into positive territory for the first time since mid-June. Long end adjusted to rising inflation expectations and increased funding needs.

Two-year yields dropped 11 bps to a near three-week low 4.77%. The market’s probability for a 25-bps rate increase at the Fed’s September 20th meeting dropped from 19% to 13%. Bond yields are at the cusp of breaking higher, yet shorter-term yields are falling along with expectations for higher policy rates.

Atlanta Fed President Bostic commented saying “jobs numbers came in as expected, I’m comfortable.” He added Fed likely to be in restrictive territory and the Fed on trajectory to get to 2% inflation. However, Mr. Bostic will not be an FOMC voter until next year.

Yield Watch

Friday/Week

  • 2-yr: -12 bps to 4.78% (-12 bps for the week)
  • 3-yr: -11 bps to 4.47% (-7 bps for the week)
  • 5-yr: -14 bps to 4.16% (-4 bps for the week)
  • 10-yr: -13 bps to 4.06% (+9 bps for the week)
  • 30-yr: –9 bps to 4.21% (+18 bps for the week)
  • Investment-grade corporate CDS gained 5.6 bps this week, the largest increase since March to 68 bps.
  • High-yield CDS jumped 27.3 bps, second only to the week of June 23rd (27.6 bps) for the largest weekly gain since March.

Key Rates and Spreads

Rates

  • 10-year Treasury bonds 4.08%, up +.12% w/w (1-yr range: 2.60-4.25) (12 year high)
  • Credit spread 1.96%, up +.13% 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%, up +0.19% w/w (1-yr range: -1.06 – 1.59) (new 40 year low)
  • 10-year minus 3-month: -1.39%, up +0.08% w/w (1-yr range: -1.69 – 2.04) (new low)
  • 2-year minus Fed funds: -0.56%, down -0.36% w/w.
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y)

Money Market Flows

  • Investment-grade bond funds posted outflows of $1.765 billion, and junk bond funds reported negative flows of $1.013 billion (from Lipper).
  • Total money market fund assets jumped $29bn to a record $5.516 TN, with a 21-week gain of $622bn (31% annualized). Total money funds were up $940bn, or 20.6%, y-o-y.
  • Total Commercial Paper fell $8.9bn to $1.166 TN. CP was down $2.9bn, or 0.2%, over the past year.

Bond auctions this week:

Just bills …

Bond auctions week ahead:

Next week will bring some new supply.

  • Monday: 13- and 26-week bills,
  • Tuesday: 52-week bills; 42-day CMB, $42 bln 3-yr Treasury note auction results at 13:00 ET
  • Wednesday: 17-week bills; $38 bln 10-yr Treasury note auction results at 13:00 ET
  • Thursday: 4- and 8-week bills, $23 bln 30-yr Treasury bond auction results at 13:00 ET; and July Treasury Budget (prior -$227.80 bln) at 14:00 ET

10 Year Note Technical Analysis via KnovaWave

Highlights – Federal Reserve

  • Federal Reserve Credit dropped $31.1bn last week to $8.190 TN.
  • Fed Credit was down $711bn from the June 22nd, 2022, peak.
  • Over the past 203 weeks, Fed Credit expanded $4.464 TN, or 120%.
  • Fed Credit inflated $5.379 TN, or 191%, over the past 560 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt jumped $15.3bn last week to $3.446 TN.
  • “Custody holdings” were up $78.7bn, 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.”

Central Bank Watch – Week Ahead Focus on Inflation and Fed Speakers

Highlights – Mortgage Market

  • Freddie Mac 30-year fixed mortgage rates jumped 12 bps to an eight-month high 6.92% (up 193bps y-o-y).
  • Fifteen-year rates rose 11 bps to 6.31% (up 205bps).
  • Five-year hybrid ARM rates gained eight bps to 6.51% (up 226bps).
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates added three bps to 7.41% (up 203bps).
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 declined four bps to 3.77% (down 79bps y-t-d).
  • Italian yields jumped 11 bps to 4.21% (down 49bps).
  • Spain’s 10-year yields rose eight bps to 3.59% (up 8bps).
  • German bund yields gained seven bps to 2.56% (up 12bps).
  • French yields increased six bps to 3.09% (up 11bps).
  • The French to German 10-year bond spread narrowed a basis points to 53 bps.
  • U.K. 10-year gilt yields rose five bps to 4.38% (up 71bps).

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 jumped eight bps to a nine-year high 0.65% (up 23bps 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

US Producer Price Disinflationary Trend Continues in June, Reprieve for Profit Margins
Consumer Inflation in June Eases, Evidence of Disinflation Encouraging Markets
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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