Bond Traders Weekly Outlook: Treasuries Rally with Flight to Safety Ahead of FOMC

U.S. Treasuries continued in the same vein as the previous week with safe haven flows from the continued fallout from the banking crisis. An intense squeeze engulfed the Treasury market. U.S. Treasuries ended the week toward their highest levels of the week. European and U.S. equities faced pressure from banks. First Republic Bank announced a suspension of its dividend and confirmed that it borrowed funds from the Fed’s discount window over the past week. This week’s action expanded the 2s10s spread by 47 bps to -42 bps and the MOVE index sailed past its pandemic high to a level not seen since 2008.

Next week will be headlined by the FOMC decision on Wednesday and monetary policy decisions from major central banks including the BoE, SNB, and Norges Bank Thursday. The Wall Street Journal’s Fed insider said during a CNBC appearance the Fed’s decision will hinge on financial stability and performance of capital markets over the next few days. The fed funds futures market, meanwhile, still sees a 65.7% implied likelihood of a 25-bps increase.

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.

Weekly Recap

With the fallout from the SVB, Signature and SI collapses the Fed now faces a serious inflation problem, along with acute system fragility. That said the Fed did get some relief from the CPI and PPI reports showing moderating prices. We also saw an acceleration of the fall in energy prices. Crude oil lost $9.81, or 12.8%, this week, the U.S. Dollar Index fell 0.6% to 103.81, losing 0.9% for the week.

A major global de-risking and deleveraging episode accelerated this week. After trading above 5% just last Thursday, two-year Treasury yields collapsed to a low of 3.71% in chaotic Wednesday trading. Two-year yields were back up to 4.25% early-Friday, before closing a wild week down 75 bps to 3.84%. Trading interest-rate derivatives was pure violence. Currencies were chaotic as Credit spreads blew out and CDS prices spiked higher.

Further tightening risks pushing the markets and economy over the proverbial cliff.

Next week will be headlined by the FOMC decision on Wednesday, and The Wall Street Journal’s Fed insider said during a CNBC appearance that the decision will hinge on financial stability and performance of capital markets over the next few days.

The fed funds futures market still sees around 60% odds of a 25bps rate hike and then expect the FOMC to end the hiking cycle. Delivering even a 25bps hike has to be accompanied by further measures to calm markets. The ECB raised 50bps this week, part of the rationale was they feared not being aggressive would signal a week market. The issues at Credit Suisse were already telling us that, however.

U.S. Treasuries ended a strong week on a higher note, sending yields back toward their lowest levels of the week. European and U.S. equities faced pressure with banks at the forefront of the weakness. First Republic Bank announced a suspension of its dividend and confirmed that it borrowed funds from the Fed’s discount window over the past week, which weighed on sentiment.

An intense squeeze engulfed the Treasury market as yield curve bets blew up. Yen shorts and levered “carry trades” were at risk as JGB and European yields sank. Corporate spreads blew out, losses on levered corporate bond portfolios were severe. Energy prices continued last week’s hard selloff. And stock market instability continued. Favored financial stocks collapsed, while the heavily shorted technology stocks rallied as did heavily shorted crypto currencies with bitcoin surging 34% this week. For the week, the KBW Bank Index sank 14.6%, while the Nasdaq100 (NDX) jumped 5.8%.

The 5-yr note and shorter tenors inched to fresh highs Friday afternoon while 10s and 30s finished just below their best levels from the late morning.

This week’s action expanded the 2s10s spread by 47 bps to -42 bps and it sent the MOVE index past its pandemic high to a level not seen since 2008.

CDS Surge

  • Credit Suisse CDS surged an unprecedented 596 this week to record 1,014 bps. In data back to 2007, the previous largest weekly increase was 66 bps in December. The largest weekly gain during the Covid crisis was 37 bps.
  • Swiss mega-bank UBS’s CDS surged 56 to 128 bps, the largest weekly gain since global crash week, September 19th 2008 (107bps).
  • Deutsche Bank CDS surged 64 bps this week, the largest weekly gain in data back to 2019 – even surpassing the two-week 60 bps Covid crisis jump in March 2020.
  • France’s Societe Generale (SocGen) CDS jumped 33 to 95 bps, the largest weekly gain in a decade.
  • Germany’s Commerze Bank CDS rose 28 this week to 94 bps, surpassing the Covid crisis for the largest weekly gain in data back to 2019.
  • Italy’s UniCredit saw CDS jump 26 this week to 122 bps, the largest weekly gain since the Covid panic.

Bank Indices Sink

  • The KBW Bank Index sank another 14.6%, after falling 15.7% the prior week, which was the largest weekly decline since the 18.8% drop during covid panic week March 20, 2020.
  • The Nasdaq Bank Index dropped 16.1%,
  • The NYSE Financials Index this week fell 7.5%.
  • The Broker/Dealer Index (XBD) lost 9.3%.
  • The European STOXX 600 Bank Index dropped 5.0%, and the Hang Seng China Financials Index fell 5.1%.

That said markets did not seize up and got nowhere near the previous 2008 levels, Scotia Bank prepared a number of key elements of the financial market we watch that help us review and visualize the cracks. It is important to tune out the noise, particular from the talking heads and dribblers that poison social media and blogs with their inane ignorance.

Bid-ask spreads:

The wider the bid-ask spread the more illiquid markets have become amid uncertainty around market conditions. Chart 4 shows that bid-ask spreads around trading in US 10-year Treasuries had widened toward levels that were close to the early stages of the pandemic, but they have quickly tightened again in the wake of policy measures and after a multi-year period of remarkable stability when buckets of liquidity were being thrown at markets. Corporate investment grade bid-ask spreads (chart 5) and high yield bid-ask spreads (chart 6) have performed similarly.

Fed’s preferred measure of how the yield curve views recession risk has deteriorated to its worst levels since 2019 when there were already concerns about the economy even before the pandemic and toward where this measure stood during the GFC (chart 3, grey bars are recessions). It has widened by about 80bps so far this month as markets have gone from soft/no landing optimism toward hard landing fears. The superiority of this measure as a recession predictor over, say, the popular 2s10s spread measure is explained here. It’s saying that the market believes that a recession is a fait accompli. It is a guide provided by a measure that can be highly volatile.

Inflation, Disinflation

Yield Watch

  • 2-yr: -32 bps to 3.82% (-77 bps for the week)
  • 3-yr: -28 bps to 3.68% (-60 bps for the week)
  • 5-yr: -28 bps to 3.47% (-48 bps for the week)
  • 10-yr: -19 bps to 3.40% (-30 bps for the week)
  • 30-yr: -12 bps to 3.60% (-10 bps for the week)
  • Investment-grade bond funds posted outflows of $3.891 billion, and junk bond funds reported negative flows of $1.427 billion (from Lipper).
  • Total money market fund assets surged $121bn to a record $5.015 TN. Total money funds were up $456bn, or 10.0%, y-o-y.
  • Total Commercial Paper fell $15.2bn to an eight-month low $1.163 TN. CP was up $146bn, or 14.3%, over the past year.

Key Rates and Spreads


  • 10-year Treasury bonds 3.41%, down -0.28 w/w (1-yr range: 1.66-4.25) (12 year high)
  • Credit spread 2.31%, up +0.22 w/w (1-yr range: 1.76-2.42)
  • BAA corporate bond index 5.72%, down -0.06 w/w (1-yr range: 4.20-6.59) (10 year+ high)
  • 30-Year conventional mortgage rate 6.55%, down -0.21% w/w (1-yr range: 4.29-7.38) (new 20 year high)

Yield Curve

  • 10-year minus 2-year: -0.89%, down -0.01% (1-yr range: -0.86 – 1.59) (new 40 year low)
  • 10-year minus 3-month: -1.27%, up +0.36% w/w (1-yr range: -1.27 – 2.04) (new low)
  • 2-year minus Fed funds: +0.01%, down -0.27% w/w.
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y)

US corporate bond spreads over US Treasuries and how they have widened as cyclical risk have risen but are well shy of the wides recorded during the early part of the pandemic, let alone the GFC. To label this as a severe credit crunch would be extreme.

10 Year Note Technical Analysis via KnovaWave

Highlights – Federal Reserve

  • Federal Reserve Credit surged $142bn last week to $8.447 TN.
  • Fed Credit was down $453bn from the June 22nd peak.
  • Over the past 183 weeks, Fed Credit expanded $4.720 TN, or 127%.
  • Fed Credit inflated $5.636 Trillion, or 201%, over the past 540 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt increased $2.2bn last week to $3.362 TN.
  • “Custody holdings” were down $73bn, or 2.1%, y-o-y.

It’s been a week since the implosion of three US banks, Silicon Valley Bank, Signature Bank and Silvergate Capital Corp. From there we saw further selling of Credit Suisse that has never recovered from Archegos and the panic selling and speculative attacks on other US Regional banks. The Federal Reserve has worked in concert with the Treasury and major money center banks to stabilize conditions. The speed of protective measures for the financial system has been impressive but with that longer-run moral hazard problems and adverse incentives are front and center.

Highlights – Mortgage Market

  • Freddie Mac 30-year fixed mortgage rates dropped 20 bps to 6.51% (up 235bps y-o-y).
  • Fifteen-year rates sank 24 bps to 5.85% (up 246bps).
  • Five-year hybrid ARM rates jumped 15 bps to 6.15% (up 296bps).
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates down six bps to 6.96% (up 246bps).
Mortgage News Daily February 17, 2023

Key Bond Auctions

Bond auctions last week:

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

Ten-year government yields down significantly.

  • Greek 10-year yields declined 19 bps to 4.13% (down 44bps y-o-y).
  • Italian yields dropped 27 bps to 4.05% (down 64bps).
  • Spain’s 10-year yields sank 32 bps to 3.23% (down 29bps).
  • German bund yields collapsed 40 bps to 2.11% (down 34bps).
  • French yields dropped 33 bps to 2.68% (down 30bps).
  • The French to German 10-year bond spread widened seven to 57 bps.
  • U.K. 10-year gilt yields sank 36 bps to 3.28% (down 39 bps).

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

Highlights – Asian Bonds

  • Japanese 10-year “JGB” yields dropped 12 bps to 0.29% (down 13bps 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)

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.’”

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

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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