Bond Traders Weekly Outlook: Treasuries Play Defense Ahead of Flood of New Supply

U.S. Treasuries ended the week on the defensive with participants eyeing a flood of new supply in coming weeks and months as the Treasury works to replenish its General Account with an estimated $1 trillion of Treasury issuance as part of the latest debt-ceiling resolution. US yields moved higher this week, despite the lower dollar and expectations of no change from the Fed. The 2-yr note yield Friday rose 10 basis points to 4.62% and the 10-yr note yield rose three basis points to 3.75%. This week tightened the 2s10s spread by five basis points to -87 bps. The market continues to anticipate no change in FOMC rates this week with that bias reinforced hen the initial jobless claims jumped to the highest level since October 2021.

The report gave renewed hope a hard landing will be avoided and at the same time the slowdown in earnings growth and the uptick in the unemployment rate suggest the Fed might lean to pause its rate hikes, or at least temper it. The feeling is the report should ease some, certainly not all of the Fed’s concerns about the tightness of the labor market and wage-push inflation going into its June FOMC meeting.

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

Treasuries ended the week lower. U.S. Treasuries ended the week on the defensive with participants eyeing a flood of new supply in coming weeks and months as the Treasury works to replenish its General Account with an estimated $1 trillion of Treasury issuance as part of the latest debt-ceiling resolution. US yields moved higher this week, despite the lower dollar and expectations of no change from the Fed. The 2-yr note yield Friday rose 10 basis points to 4.62% and the 10-yr note yield rose three basis points to 3.75%. This week tightened the 2s10s spread by five basis points to -87 bps.

The jobless claims report on top of last week’s employment report gave renewed hope a hard landing will be avoided and at the same time the slowdown in earnings growth and the uptick in the unemployment rate suggest the Fed might lean to pause its rate hikes, or at least temper it. The feeling is the report should ease some, certainly not all of the Fed’s concerns about the tightness of the labor market and wage-push inflation going into its June FOMC meeting.

Yield Watch

Friday/Week

  • 2-yr: +10 bps to 4.62% (+11 bps for the week)
  • 3-yr: +9 bps to 4.26% (+12 bps for the week)
  • 5-yr: +6 bps to 3.92% (+8 bps for the week)
  • 10-yr: +3 bps to 3.75% (+6 bps for the week)
  • 30-yr: +1 bp to 3.89% (+1 bp for the week)

Key Rates and Spreads

Rates

  • 10-year Treasury bonds 3.75%, up +0.05% w/w (1-yr range: 2.60-4.25) (12 year high)
  • Credit spread 2.05%, down -0.01 w/w (1-yr range: 1.76-2.42)
  • BAA corporate bond index 5.80%, up +0.04 w/w (1-yr range: 5.00-6.59) (10 year+ high)
  • 30-Year conventional mortgage rate 6.90%, up +0.02% w/w (1-yr range: 5.05-7.38) (new 20 year high)

Yield Curve

  • 10-year minus 2-year: -0.86%, down -0.05% w/w (1-yr range: -0.86 – 1.59) (new 40 year low)
  • 10-year minus 3-month: -1.53%, up +0.16% w/w (1-yr range: -1.69 – 2.04) (new low)
  • 2-year minus Fed funds: -0.48%, up +0.10% w/w
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y)
Robust U.S. Economy Added 339,000 Jobs in May, Unemployment Rose 3.7% From 3.4%

The report gave renewed hope a hard landing will be avoided and at the same time the slowdown in earnings growth and the uptick in the unemployment rate suggest the Fed might lean to pause its rate hikes, or at least temper it. The feeling is the report should ease some, certainly not all of the Fed’s concerns about the tightness of the labor market and wage-push inflation going into its June FOMC meeting.

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 $539 million, and junk bond funds reported positive flows of $2.500 billion (from Lipper).
  • Total money market fund assets jumped another $36.7bn to a record $5.457 TN, with a 13-week gain of $563bn (54% annualized). Total money funds were up $904bn, or 19.9%, y-o-y.
  • Total Commercial Paper was little changed at $1.111 TN. CP was down $47bn, or 4.0%, over the past year.

No Bond auctions this week:

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 $26.7bn last week to $8.353 TN.
  • Fed Credit was down $548bn from the June 22nd peak.
  • Over the past 195 weeks, Fed Credit expanded $4.627 TN, or 124%.
  • Fed Credit inflated $5.542 TN, or 197%, over the past 552 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt declined $2.5bn last week to $3.407 TN.
  • “Custody holdings” were up $12.6bn, or 0.4%, y-o-y.

The Markets are priced for around a one-in-three chance of a 25bps hike this week and a terminal rate of 5¼% that signals market expectations that the Fed is done hiking rates. The vast majority within the consensus of over 100 forecasters of various ilk also expect a hold. A lot may depend on Tuesday morning’s CPI update. If core CPI is hot again then it may tip the balance toward a hike particularly in the wake of the strong payrolls report.

Federal Reserve Raises Rates 25bps as Expected, Removes Additional Firming May be Appropriate

Jay Powell’s press conference was ‘uncontroversial’. We did see some contrition from him “We are committed to learning the right lessons from this episode and will work to prevent events like these from happening again.”

A bit late given we have seen indefensible mistakes made in pathetic bank regulation. We had inflation mismanagement that is at risk of historic failure. Banking instability adds to downside economic risks, containing inflation leant the bank, at tleast in this meeting to err on the side of overing crushing the economy. Powell repeatedly reminds the risk of repeating past mistakes, where Fed inflation fights ended prematurely.

The FOMC meeting came in the midst of chaos. There was a strong case for the Fed to put off another rate increase. The unfolding banking crisis ensures tighter credit for an economy already downshifting. The case for hiking rates was equally compelling. Inflation remains elevated, with recent data consistently pointing to sticky price pressures. Friday’s strong payroll data, including NFP 253,000 jobs added and a 0.5% (4.4% y-o-y) gain in Average Hourly Earnings confirmed unrelenting labor market tightness.

Bloomberg’s Mike McKee: “Markets have priced in rate cuts by the end of the year. Do you rule that out?”

Chair Powell: “We on the Committee have a view that inflation is going to come down, not so quickly, but it’ll take some time. And in that world, if that forecast is broadly right, it would not be appropriate to cut rates, and we won’t cut rates. If you have a different forecast – markets have been from time-to-time pricing in quite rapid reductions in inflation – we’d factor that in. But that’s not our forecast. And, of course, the history of the last two years has been very much that inflation moves down [gradually]. Particularly now, if you look at non-housing services, it really, really hasn’t moved much. And it’s quite stable. So, we think we’ll have to – demand will have to weaken a little bit and labor market conditions may have to soften a bit more to begin to see progress there. And, again, in that world, it wouldn’t be appropriate for us to cut rates.”

Central Bank Watch – Deluge of BOE, ECB and Fed Speakers including Powell and Bernanke

Highlights – Mortgage Market

  • Freddie Mac 30-year fixed mortgage rates dropped 15 bps to 6.78% (up 155bps y-o-y).
  • Fifteen-year rates also fell 15 bps to 6.16% (up 178bps).
  • Five-year hybrid ARM rates dipped three bps to 6.38% (up 226bps) – near the high since October 2008.
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates up 10 bps to 7.05% (up 148bps).
Mortgage News Daily
US Mortgage Applications Fall 4.6% With Mortage Rates Highest Since March

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 declined four bps to 3.64% (down 92bps y-t-d).
  • Italian yields gained four bps to 4.11% (down 58bps).
  • Spain’s 10-year yields rose five bps to 3.36% (down 15bps).
  • German bund yields gained six bps to 2.38% (down 7bps).
  • French yields increased six bps to 2.92% (down 6bps).
  • The French to German 10-year bond spread was little changed at 54 bps.
  • U.K. 10-year gilt yields jumped eight bps to 4.24% (up 57bps).

Gilts Sold Reminds us of Risk

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.

This all happened quickly…. just months ago we had:

German 10-Year Bunds at Weakest Level since July 2011 as Yield Curve Inversion Deepens

Highlights – Asian Bonds

  • Japanese 10-year “JGB” yields added a basis point to 0.43% (up 1bp 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)
Deja Vu as Dollar Yen Soars After Bank of Japan Keeps Monetary Policy Steady, No Change to JGB Yield Band

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

Robust Increase in Real Spending with Core PCE Inflation at Persistently High Levels in April
US Producer Price Inflation Moderates Again in April, +2.3% versus +2.7% in March
Consumer Inflation in April Eases with Fed Screws Tightening, Core CPI Stays Elevated
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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