Bond Traders Weekly Outlook: Two Year Rates Jump in U.S., U.K and E.U on Inflation Fears

U.S. Treasuries ended the week lower as yields on short-term government debt in the US, UK and eurozone have begun to rise again anticipating more prolonged rate increases to contend with price rises. Rate hike expectations continued growing with the fed funds futures market now showing a 66.5% implied likelihood of another 25-bps increase in June, up from 17.4% a week ago. In the U.K. two-year gilts had one of the biggest weekly falls in 20 years. The entire Treasury complex fell Friday after the release of sstronger than expected data. This week’s underperformance in shorter tenors put significant pressure on the 2s10s spread, compressing it by 18 bps to -76 bps

Release of the Personal Income/Outlays report for April, which showed higher-than-expected spending growth and a persistently high PCE Price Index growth. At the same we saw a stronger than expected Durable Orders report (actual 1.1%; consensus -1.0%). On Monday the U.S. bond market is closed in observance of Memorial Day in a new tab)

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

The 2-yr note yield rose seven basis points to 4.56%, rising 29 basis points this week to 4.56%. The 10-yr note yield fell one basis point to 3.80% Friday, rising 11 basis points this week to 3.80%. This week’s underperformance in shorter tenors put significant pressure on the 2s10s spread, compressing it by 18 bps to -76 bps

U.S. Treasuries ended the week mostly lower note, widening their losses from this week. The entire complex fell after the release of the Personal Income/Outlays report for April, which showed in-line income growth (actual 0.4%) coupled with higher-than-expected spending growth (actual 0.8%; 0.4%) and a persistently high PCE Price Index growth (4.4% yr/yr). At the same we saw a stronger than expected Durable Orders report (actual 1.1%; consensus -1.0%) briefly sending 10s and 30s into the red, though both tenors returned into positive territory as the day went on.

Rate hike expectations continued growing with the fed funds futures market now showing a 66.5% implied likelihood of another 25-bps increase in June, up from 17.4% a week ago.

Today’s underperformance in shorter tenors took place alongside a rally in the Nasdaq (+2.0%) lead by the 25% rise of NVidia on earnings and the AI mania, which sent the index to within 2.0% of its high from August.

In the US there is also the ongoing debt ceiling saga, a surging Nasdaq and strong US dollar. U.S. Treasuries auctions all saw excellent this week, $35bln 7-yr note auction, $43bln 5-yr note auction and a $42bln 2-yr note auction. On Monday the bond market is closed in observance of Memorial Day.

Gilts Sold

The yield on UK two-year debt rose 0.6 percentage points this 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.

Bond auctions this week:

U.S. Treasuries completed this week’s note auctions with excellent demand for the $35 bln 7-yr note auction. The sale drew a high yield of 3.827%, which stopped through by 0.8 bps versus the when-issued yield, the bid-to-cover ratio (2.61x) and indirect takedown (72.3%) were well above average. The fixed interest desk rated the auction an A. Wednesday treasury completed a $43 bln 5-yr note auction which met strong demand. Tuesday, we saw a $42 bln 2-yr note C rated auction.

Money Market Flows

  • Investment-grade bond funds posted inflows of $3.015 billion, while junk bond funds reported positive flows of $1.399 billion (from Lipper).
  • Total money market fund assets surged $47bn to a record $5.388 TN, with a 11-week gain of $495bn. Total money funds were up $859bn, or 19.0%, y-o-y.
  • Total Commercial Paper fell $12.4bn to $1.127 TN. CP was down $5.0bn, or 0.4%, over the past year

Yield Watch


  • 2-yr: +7 bps to 4.56% (+29 bps for the week)
  • 3-yr: +6 bps to 4.23% (+27 bps for the week)
  • 5-yr: +3 bps to 3.93% (+18 bps for the week)
  • 10-yr: -1 bp to 3.80% (+11 bps for the week)
  • 30-yr: -4 bps to 3.96% (+1 bp for the week)

U.S. Treasuries finished April with solid gains across the curve following the release of the Bank of Japan’s first policy statement under Kazuo Ueda. The BoJ made no changes to its ultra-loose policy, but it replaced a pledge to keep rates at or below current levels with guidance for continued yield curve control with an aim of achieving the price stability target.

Key Rates and Spreads


  • 10-year Treasury bonds 3.81%, up +0.11% w/w (1-yr range: 2.60-4.25) (12 year high)
  • Credit spread 2.12%, down -0.03 w/w (1-yr range: 1.76-2.42)
  • BAA corporate bond index 5.93%, up +0.08 w/w (1-yr range: 5.00-6.59) (10 year+ high)
  • 30-Year conventional mortgage rate 7.14%, up +0.32% w/w (1-yr range: 5.05-7.38) (new 20 year high)

Yield Curve

  • 10-year minus 2-year: -0.76%, down -0.16% w/w (1-yr range: -0.86 – 1.59) (new 40 year low)
  • 10-year minus 3-month: -1.51%, up +0.08% w/w (1-yr range: -1.17 – 2.04) (new low)
  • 2-year minus Fed funds: -0.51%, up +0.27% w/w w/w
  • This week’s underperformance in shorter tenors put significant pressure on the 2s10s spread, compressing it by 18 bps to -76 bps
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y)

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.

10 Year Note Technical Analysis via KnovaWave

Highlights – Federal Reserve

  • Federal Reserve Credit declined $42.3bn last week to $8.406 TN.
  • Fed Credit was down $495bn from the June 22nd peak.
  • Over the past 193 weeks, Fed Credit expanded $4.679 TN, or 126%.
  • Fed Credit inflated $5.595 TN, or 199%, over the past 550 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt increased $7.9bn last week to an 11-month high $3.398 TN.
  • “Custody holdings” were down $27bn, or 0.8%, y-o-y.

Rate hike expectations continued growing with the fed funds futures market now showing a 66.5% implied likelihood of another 25-bps increase in June, up from 17.4% a week ago.

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.”

Highlights – Mortgage Market

  • Freddie Mac 30-year fixed mortgage rates surged 25 bps to a six-month high 6.76% (up 166bps y-o-y).
  • Fifteen-year rates jumped 29 bps to 6.09% (up 178bps).
  • Five-year hybrid ARM rates spiked 29 bps to 6.28% (up 208bps) – the high since October 2008.
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates up 16 bps to 7.17% (up 193bps).
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 fell 10 bps to 3.89% (down 67bps y-t-d).
  • Italian yields jumped 12 bps to 4.39% (down 31bps).
  • Spain’s 10-year yields rose 13 bps to 3.61% (up 9bps).
  • German bund yields gained 11 bps to 2.54% (up 9bps).
  • French yields rose 11 bps to 3.11% (up 13bps).
  • The French to German 10-year bond spread was unchanged at 57 bps.
  • U.K. 10-year gilt yields surged 34 bps to 4.33% (up 66bps). 

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

Highlights – Asian Bonds

  • Japanese 10-year “JGB” yields added two bps to 0.42% (unchanged 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

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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