Bond Traders Weekly Outlook: Treasuries Gain as Recession, Flight to Safety Risks Grow

U.S. Treasuries showed solid gains across the curve to finish the week. Friday’s move was fueled by flash June Manufacturing and Services PMI readings from major economies. These came at the time major central banks including the Fed, BoC, RBA, SNB, ECB, and the Bank of England are threatening more rate hikes. This week’s underperformance in shorter tenors put additional pressure on the 2s10s spread, which compressed by seven basis points since last Friday to -101 bps. U.S. Treasuries $12 billion 20-yr bond reopening met stellar demand, reflecting continued strong appetite for U.S. government debt. WTI crude oil widened this week’s loss to $2.74, or 3.8%, week while the U.S. Dollar Index rose 0.5% to 102.91, gaining 0.6% for the week.

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 showed solid gains across the curve to finish the week. Friday’s move was fueled by flash June Manufacturing and Services PMI readings from major economies. These came at the time major central banks including the Fed, BoC, RBA, SNB, ECB, and the Bank of England are threatening more rate hikes. This week’s underperformance in shorter tenors put additional pressure on the 2s10s spread, which compressed by seven basis points since last Friday to -101 bps. U.S. Treasuries $12 billion 20-yr bond reopening met stellar demand, reflecting continued strong appetite for U.S. government debt.

WTI crude oil widened this week’s loss to $2.74, or 3.8%, week while the U.S. Dollar Index rose 0.5% to 102.91, gaining 0.6% for the week.

Yield Watch

Friday/Week

  • 2-yr: -5 bps to 4.75% (+4 bps for the week)
  • 3-yr: -4 bps to 4.33% (+1 bp for the week)
  • 5-yr: -5 bps to 4.00% (+1 bp for the week)
  • 10-yr: -6 bps to 3.74% (-3 bps for the week)
  • 30-yr: -5 bps to 3.82% (-4 bps for the week)

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)

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%
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 $2.170 billion, and junk bond funds reported positive flows of $265 million (from Lipper).
  • Total money market fund assets declined $18.2bn to $5.434 TN, but have posted a 15-week gain of $540bn (38% annualized). Total money funds were up $891bn, or 19.6%, y-o-y.
  • Total Commercial Paper gained $13.4bn $1.144 TN. CP was unchanged 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:

  • U.S. Treasuries pulled off lows as the bond market responded to Friday’s $12 billion 20-yr bond reopening, which met stellar demand. The sale drew a high yield of 4.010%, which stopped through the when-issued yield by 1.8 bps while the bid-to-cover ratio (2.87x) and indirect takedown (74.6%) were well above their respective 12-auction averages, reflecting continued strong appetite for U.S. government debt.
Strong International Demand for U.S. Government Debt in Stellar 20-year Bond Auction

10 Year Note Technical Analysis via KnovaWave

Two Year Treasury Volatility was Historic in the First Quarter of 2023

  • Two-year Treasury yields began 2023 at 4.43% then fell to 4.10% by February 2nd.
  • Yields then surged almost 100 bps to trade to 5.07% on March 8th. Volatility was on steroids.
  • Yields were down to 3.71% intraday on the 15th, only to rally back to 4.25% on the 17th.
  • They sank to a low of 3.63% on the 20th, back up to 4.25% on the 22nd,
  • Then down to 3.55% on the 24th
  • Ended the quarter at 4.03%.
  • The yield on the 2-year Treasury fell to 4.06%, down 3.7 basis points on Friday and posting the biggest monthly drop since January 2008, in March the yield fell 73.5 basis points. Its first quarterly retreat in eight quarters.
  • The yield on the 10-year Treasury was at 3.491%, off 5.9 basis points, and recording its sharpest monthly fall since March 2020.
  • The yield on the 30-year Treasury declined to 3.688%, down 5.7 basis points, while setting its biggest monthly decline since January.

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 $17.9bn last week to $8.335 TN.
  • Fed Credit was down $566bn from the June 22nd peak.
  • Over the past 197 weeks, Fed Credit expanded $4.608 TN, or 124%.
  • Fed Credit inflated $5.524 TN, or 197%, over the past 554 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt jumped $16.3bn last week to $3.425 TN.
  • “Custody holdings” were up $22.1bn, or 0.7%, y-o-y.
Federal Reserve Leave Rates Unchanged as Expected. See 5.6% Fed Fund Rate at Year End

Two-year Treasury yields rose 12 bps this week to 4.71%, the high since the SVB blowup. The market sees a 72% probability of a 25 bps hike at the Fed’s July 26th meeting, with peak Fed funds now at 5.30% for the September 20th meeting. The market is pricing only one rate cut by the January 31, 2024, meeting.

Central Bank Watch – Banker Torment, SNB, Norges Bank, Turkey and BOE all Raised Rates

Highlights – Mortgage Market

  • Freddie Mac 30-year fixed mortgage rates declined four bps to 6.63% (up 82bps y-o-y).
  • Fifteen-year rates dipped four bps to 6.03% (up 111bps).
  • Five-year hybrid ARM rates sank 31 bps to 6.12% (up 171bps).
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates up six bps to 7.07% (up 118bps).
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 dropped 18 bps to 3.58% (down 98bps y-t-d).
  • Italian yields declined six bps to 3.98% (down 72bps).
  • Spain’s 10-year yields fell seven bps to 3.31% (down 20bps).
  • German bund yields dropped 12 bps to 2.35% (down 9bps).
  • French yields fell 10 bps to 2.88% (down 10bps).
  • The French to German 10-year bond spread widened two to 53 bps.
  • U.K. 10-year gilt yields declined nine bps to 4.32% (up 65bps).

Gilts Sold Reminds Us of Risk.

  • UK two-year yields spiked 40 bps this week 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 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 we 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 declined four bps to 0.37% (down 5bp 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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