Bond Traders Weekly Outlook: Specters of New Supply, FOMC and PCE Ahead

U.S. Treasuries corrected some of last week’s rally except with the long bond that actually gained 2 basis points on the week. Weakness was in the short end with the 2-year losing 13 bps for the week. The specter of new supply could be weighing as could the specter of Fed Chair Powell trying to rein in the “one and done” mantra. There could be residual activity around last week’s inflation reports before PCE lands post the next Fed meeting. 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.

The market is poised for a heavy weak of central bank meetings and data. The market has a FOMC meeting on Wednesday, the ECB meeting on Thursday, and the BOJ meeting on Friday. Next week will bring some new supply. There is a $42 billion, 2-yr note auction on Monday, a $43 billion, 5-yr note auction on Tuesday, and a $35 billion 7-yr note auction on Thursday.

Hungry Bond Traders

There is a lot of data for central banks to chew over. Due out is US GDP, June’s personal outlays and income, PCE price index, flash S&P Global PMI surveys, Case-Shiller home prices, second-quarter employment cost index, new and pending home sales, and consumer confidence updates. U.S. Treasuries completed a gave a C- $12 bln 20-yr bond reopening.

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 corrected some of last week’s rally except with the long bond that actually gained 2 basis points on the week. Weakness was in the short end with the 2-year losing 13 bps for the week. There could be residual activity around last week’s inflation reports before PCE lands post the next Fed meeting. 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.

U.S. Treasuries completed a gave a C- $12 bln 20-yr bond reopening.

The market is poised for a heavy weak of central bank meetings and data. The market has a FOMC meeting on Wednesday, the ECB meeting on Thursday, and the BOJ meeting on Friday. There is a lot of data for central banks to chew over. Due out is US GDP, June’s personal outlays and income, PCE price index, flash S&P Global PMI surveys, Case-Shiller home prices, second-quarter employment cost index, new and pending home sales, and consumer confidence updates. Market financial conditions have become extraordinarily loose. The reversal of short positions and hedges provided powerful liquidity support this month throughout Treasury and fixed-income markets (MBS).

Yield Watch

Friday/Week

  • 2-yr: +1 bp to 4.85% (+13 bps for the week)
  • 3-yr: +2 bps to 4.45% (+9 bps for the week)
  • 5-yr: unch at 4.10% (+7 bps for the week)
  • 10-yr: unch at 3.85% (+3 bps for the week)
  • 30-yr: unch at 3.91% (-2 bps for the week)

Key Rates and Spreads

Rates

  • 10-year Treasury bonds 3.84%, up +.02% w/w (1-yr range: 2.60-4.25) (12 year high)
  • Credit spread 1.86%, up +.01% w/w (1-yr range: 1.76-2.42)
  • BAA corporate bond index 5.70%, up +.03% w/w (1-yr range: 5.00-6.59) (10 year+ high)
  • 30-Year conventional mortgage rate 7.00%, up +0.13% w/w (1-yr range: 5.05-7.38) (new 20 year high)

Yield Curve

  • 10-year minus 2-year: -1.01%, down -0.07% w/w (1-yr range: -1.06 – 1.59) (new 40 year low)
  • 10-year minus 3-month: -1.58%, unchanged w/w (1-yr range: -1.69 – 2.04) (new low)
  • 2-year minus Fed funds: -0.23%, up +0.09%
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. Week 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 $1.964 billion, and junk bond funds reported positive flows of $2.216 billion (from Lipper).
  • Total money market fund assets added $4bn to $5.458 TN, with a 19-week gain of $565bn (32% annualized). Total money funds were up $885bn, or 19.3%, y-o-y.
  • Total Commercial Paper rose $15.0bn to a 19-week high $1.183 TN. CP was up $11bn, or 0.9%, 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 Domestic Demand in 20-year Bond Auction Reflecting Curve Divergence

Bond auctions week ahead:

Next week will bring some new supply. There is a $42 billion, 2-yr note auction on Monday, a $43 billion, 5-yr note auction on Tuesday, and a $35 billion 7-yr note auction on Thursday.

  • Monday: 13- and 26-week bills, $42 billion 2-yr note auction
  • Tuesday: 52-week bills; 42-day CMB, $43 billion, 5-yr note auction
  • Wednesday: 17-week bills;
  • Thursday: 4- and 8-week bills, $35 billion 7-yr note auction

10 Year Note Technical Analysis via KnovaWave

Highlights – Federal Reserve

  • Federal Reserve Credit declined $10.7bn last week to $8.250 TN.
  • Fed Credit was down $617bn from the June 22nd, 2022, peak.
  • Over the past 201 weeks, Fed Credit expanded $4.523 TN, or 121%.
  • Fed Credit inflated $5.438 TN, or 193%, over the past 558 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt declined $5.5bn last week to $3.431 TN.
  • “Custody holdings” were up $79bn, or 2.4%, y-o-y.
  • The fed funds futures market is pricing in a 99.8% probability of a 25-basis points rate hike. The questions revolve around what Fed Chair Powell signals about additional rate hikes after the July meeting.
  • Fed funds futures are pricing the July rate hike as the last in the tightening cycle. There is only a 16% probability of a second-rate hike at the September meeting, a 30.7% probability of a second-rate hike at the November meeting, and a 27.3% probability of a second-rate hike at the December meeting, according to the CME FedWatch Tool.
Federal Reserve Leave Rates Unchanged as Expected. See 5.6% Fed Fund Rate at Year End
Central Bank Watch – Week Ahead Brings PBOC, South Africa, Turkey and Russia Rate Meetings

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.

Last week ahead of the CPI data and following the hot ADP report we had the following reaction. Was this a washout or the signal of more to come?

  • 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.

Highlights – Mortgage Market

  • Freddie Mac 30-year fixed mortgage rates dropped 30 bps to 6.72% (up 118bps y-o-y).
  • Fifteen-year rates sank 37 bps to 6.07% (up 132bps).
  • Five-year hybrid ARM rates slipped a basis point to 6.59% (up 228bps) – near the high in data back to 2005.
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates up four bps to 7.18% (up 158bps).
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 sank 16 bps to 3.79% (down 78bps y-t-d).
  • Italian yields fell nine bps to 4.08% (down 62bps).
  • Spain’s 10-year yields declined five bps to 3.48% (down 4bps).
  • German bund yields fell four bps to 2.47% (up 2bps).
  • French yields declined four bps to 2.99% (up 1bp).
  • The French to German 10-year bond spread was little changed at 52 bps.
  • U.K. 10-year gilt yields sank 16 bps to 4.28% (up 61bps).

Gilts Sold Reminds Us of Risk.

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. 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 declined three bps to 0.45% (up 3bps 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 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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