Bond Traders Weekly Outlook: Safe Haven Versus Treasury Supply

U.S. Treasuries ended the week with solid gains in longer tenors while the 2-yr note finished closer to flat. The week began with safe haven Treasury buying, by week’s end safe haven buying was evident in gold and oil but in comparison was subdued in bonds. The reality massive government deficits mean Treasury supply, with more expected with the war machine in full cry. The Middle East crisis hits with global de-risking/deleveraging already in full cry. How will the Fed react to market illiquidity and dislocation? Inflation risk remains highly elevated. September U.S. CPI came in hotter in the key core services segment and the preliminary reading of the University of Michigan’s Consumer Sentiment survey showed an uptick in one- and five-year inflation expectations.

This week’s outperformance in longer tenors put renewed pressure on the 2s10s spread, compressing it by 14 bps to -42 bps. Crude oil ripped back up to levels from last week while the U.S. Dollar Index rose 0.1% to 106.68, gaining 0.6% for the week.

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.

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.

“Losses on longer-dated Treasuries are beginning to rival some of the most notorious market meltdowns in US history. Bonds maturing in 10 years or more have slumped 46% since peaking in March 2020… That’s just shy of the 49% plunge in US stocks in the aftermath of the dot-com bust at the turn of the century. The rout in 30-year bonds has been even worse, tumbling 53%, nearing the 57% slump in equities during the depths of the financial crisis.” October 4 – Bloomberg (Ye Xie):

Weekly Recap

U.S. Treasuries ended the week with solid gains in longer tenors while the 2-yr note finished closer to flat. The week began with safe haven Treasury buying, by week’s end safe haven buying was evident in gold and oil but in comparison was subdued in bonds. The reality massive government deficits mean Treasury supply, with more expected with the war machine in full cry.

The Middle East crisis hits with global de-risking/deleveraging already in full cry. How will the Fed react to market illiquidity and dislocation? The weekend escalation in the Israel-Gaza conflict after more than a million residents were warned to evacuate the conflict area in the next 24 hours will greet us on Monday.

Inflation risk remains highly elevated. September U.S. CPI came in hotter in the key core services segment and the preliminary reading of the University of Michigan’s Consumer Sentiment survey showed an uptick in one- and five-year inflation expectations.

This week’s outperformance in longer tenors put renewed pressure on the 2s10s spread, compressing it by 14 bps to -42 bps. Crude oil ripped back up to levels from last week while the U.S. Dollar Index rose 0.1% to 106.68, gaining 0.6% for the week.

With the markets and MSM focused on geopolitical worries the release of global economic went largely unnoticed. These included including China’s trade balance ($77.21 bln; expected $70.00 bln) report that showed decreases in imports (-6.2% yr/yr; expected -6.0%) and exports (-6.2% yr/yr; expected -7.6%) and cooler than expected CPI (0.0% yr/yr; expected 0.2%) and PPI (-2.5% yr/yr; expected -2.4%).

Friday’s report on University of Michigan Consumer Confidence one-year inflation expectations jumped from 3.2% to a five-month high of 3.8%. This followed Wednesday’s stronger-than-expected 0.5% increase in Producer Prices, with worrying 1.8% (0.5%, 0.7% and 0.6%) three-month inflation. Thursday’s CPI was reported at a stronger-than-expected 0.4% for the month (following August’s 0.6%).

US Producer Prices Higher in September, Pass Through Effects to Consumer Worry

Inflation is demonstrating unmistakable persistence, with Middle East instability posing a clear and present danger of higher crude prices. Moreover, an increasingly fragmented global economy elevates the risk of supply chain issues and resource scarcities.

Consumer Inflation Rises +0.4% in September with Hot Core Services Sector

This week we saw 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 continued to move higher despite a growing sense that the bond and stock market are oversold in the short-term and due for a bounce. The 10-yr note yield jumped another 20 basis points this week to 4.78% and the 2-yr note yield rose two basis points to 5.06%. The 10-year term premium has climbed by around130bps since summer and back to highs last seen in 2021 in the early days of the pandemic recovery.

De-risking and deleveraging gained momentum this week,

Much to do with margin covering. Global yields spike with notable pain for the European periphery.

  • Both U.S. investment-grade and high yield corporate CDS closed the week higher. Bank CDS bucked the trend, with Friday’s solid earnings reports sustaining early week CDS declines.
  • Emerging Market CDS shot higher, with a notable nine bps jump Friday to 237 bps.
  • Israel CDS rose 13 Friday (33 for the week) to a decade-high 133 bps. The Friday surge in Middle East sovereign CDS contributed to a portentous session. Qatar CDS rose seven (up 16bps on the week) to a one-year high 62 bps, and Saudi Arabia five (9bps) to a 14-month high 69 bps. Bahrain rose seven (16bps) to 255 bps; Dubai nine (14bps) to 92 bps; and Kuwait two (11bps) to 64 bps.

Key Catalysts that empowered latest Treasury sell off:

“Based on projected intermediate- to long-term borrowing needs, Treasury intends to gradually increase coupon auction sizes beginning with the August to October 2023 quarter. While these changes will make substantial progress towards aligning auction sizes with intermediate- to long-term borrowing needs, further gradual increases will likely be necessary in future quarters.”

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.”

September 19 – Reuters (Rodrigo Campos): “Global debt hit a record $307 trillion in the second quarter of the year despite rising interest rates curbing bank credit, with markets such as the United States and Japan driving the rise, the Institute of International Finance (IIF) said… The financial services trade group said… global debt in dollar terms had risen by $10 trillion in the first half of 2023 and by $100 trillion over the past decade. It said the latest increase has lifted the global debt-to-GDP ratio for a second straight quarter to 336%. Prior to 2023, the debt ratio had been declining for seven quarters.”

Yield Watch

Friday/Week

  • 2-yr: -1 bp to 5.05% (-1 bp for the week)
  • 3-yr: -2 bps to 4.82% (-6 bps for the week)
  • 5-yr: -6 bps to 4.64% (-11 bps for the week)
  • 10-yr: -8 bps to 4.63% (-15 bps for the week)
  • 30-yr: -9 bps to 4.78% (-16 bps for the week)

Key Rates and Spreads

Rates

  • 10-year Treasury bonds 4.80%, up +0.22% w/w (2.60-4.80) (new 15 year high 10/6/23 w/e)
  • Credit spread 1.77%, down -..04% w/w (1.77-2.42) (new 1 year low 10/6/23 w/e)
  • BAA corporate bond index 6.57%, up +0.18% w/w (1-yr range: 5.28-6.59) (10 year+ high)
  • 30-Year conventional mortgage rate 7.84%, up +0.40% w/w (5.05-7.84) (new 23 year high 10/6/23 w/e)

Yield Curve

  • 10-year minus 2-year: -0. 39%, up +0.09% w/w (1-yr range: -1.06 – 1.59) (new 40 year low)
  • 10-year minus 3-month: -0.71%,up +0.17% w/w (1-yr range: -1.69 – 2.04)
  • 2-year minus Fed funds: -0.24%, up +0.03% w/w
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y)

Money Market Flows

  • Total money market fund assets were little changed at $5.706 TN, with a 31-week gain of $813bn (28% annualized). Total money funds were up $1.118 TN, or 24.4%, y-o-y.
  • Total Commercial Paper rose gained $7.9bn to $1.210 TN. CP was down $46bn, or 3.7%, over the past year.

Bond auctions this week:

Weak 30-year Treasury Bond Auction With 3.7 bps Tail Completes Week’s Offerings
U.S. 10-year Bond Auction Auctioned at 4.61%, Highest Yield at Auction Since 2007 Ahead of CPI
Dismal 3-year Bond Auction in Another Week of Heavy Supply Gets an F Rating

Bond auctions week ahead:

Next week will bring some new supply.

  • Monday: 13- and 26-week bills
  • Tuesday:  42-Day bills
  • Wednesday: 17-week bills $13 bln 20-yr Treasury bond reopening results at 13:00 ET
  • Thursday: 4- and 8-week bills;

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

Central Bank Watch – Week Ahead Focus on FOMC and ECB Minutes

Highlights – Federal Reserve

  • Federal Reserve Credit declined $29.8bn last week to $7.915 TN.
  • Fed Credit was down $986bn from the June 22nd, 2022, peak.
  • Over the past 212 weeks, Fed Credit expanded $4.188 TN, or 112%.
  • Fed Credit inflated $5.104 TN, or 182%, over the past 570 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt increased $0.9bn last week to $3.425 TN.
  • “Custody holdings” were up $100bn, or 3.0%, y-o-y.

Market probabilities for a Fed rate increase at the November 1st FOMC meeting pricing in a roughly 15% chance of the central bank’s raising rates next month, from around 27% last week.

Central Bank Watch – Week Ahead Focus on PBOC and Fed’s Powell

Powell at the FOMC: “I guess it’s fair to say that the economy has been stronger than many expected, given what’s been happening with interest rates. Why is that? Many candidate explanations. Possibly a number of them make sense. One is just that household balance sheets and business balance sheets have been stronger than we had understood, and so that spending has held up and that kind of thing. We’re not sure about that.”

Federal Reserve Kept Rates at 22-Year High 5.25-5.50% Range as Expected

Highlights – Mortgage Market

  • Freddie Mac 30-year fixed mortgage rates rose bps to 7.63% (up 71bps y-o-y) – the high since November 2000.
  • Fifteen-year rates jumped 12 bps to 7.01% (up 92bps) – the high since December 2000.
  • Five-year hybrid ARM rates gained 13 bps to 7.27% (up 146bps).
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates down seven bps to 7.81% (up 64bps).
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.

Major Benchmark 10-year Bond markets

Bond Market Performance 2023

Major 10-year Bonds/Notes

Highlights – European Bonds

  • Greek 10-year yields fell nine bps to 4.29% (down 28bps y-t-d).
  • Italian yields dropped 14 bps to 4.78% (up 8bps).
  • Spain’s 10-year yields fell 13 bps to 3.88% (up 37bps).
  • German bund yields dropped 15 bps to 2.74% (up 29bps).
  • French yields declined 11 bps to 3.37% (up 39bps).
  • The French to German 10-year bond spread widened four to 63 bps.
  • U.K. 10-year gilt yields dropped 19 bps to 4.39% (up 71bps).

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 declined four bps to 0.76% (up 34bps y-t-d).

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

Core PCE inflation Decelerated in August, Though Energy Prices Cause Concern
US Producer Prices Higher in August, Cost of Gasoline Surged 20%
Cost of Living Crisis Deepens as Consumer Inflation Rises +0.6% in August
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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