Bond Traders Weekly Outlook: US Treasuries Underperformance in Longer Tenors Strains

De-risking and deleveraging gained momentum this week, much to do with margin covering. Global yields spike with notable pain for the European periphery. U.S. Treasuries saw fresh lows for the year this week but at least finished September on a higher note. Treasuries got support from the Personal Income (actual 0.4%; consensus 0.5%) and Personal Spending (actual 0.4%; consensus 0.5%) report for August missed expectations, showing some moderation in the yr/yr core PCE rate to 3.9% from 4.3% in July. There is much uncertainty, a UAW strike, government shutdowns and margin deficiencies. Another underperformance in longer tenors expanded the 2s10s spread by 21 bps to -47 bps. For the month, the 2s10s spread expanded by 30 bps.

Crude oil pulled back from highs but still gained more than $7.00/bbl for the month, while the U.S. Dollar Index dipped 0.1% to 106.15, narrowing this week’s gain to 0.5%. The Index rose 2.4% in September.

Hungry Bond Traders

There is a firm belief the Central Banks have been 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.

The longer rates stay elevated the risk of a downturn increases. This is telling at the margin with more signs of consumer stress as higher borrowing costs and weaker hiring start to eat into household spending. With the Fed seen being close to its policy rate peak, next up is focusing on growth softening.

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

A busy week for bond traders, U.S. Treasuries saw fresh lows for the year this week but at least finished September on a higher note. Treasuries got support from the Personal Income (actual 0.4%; consensus 0.5%) and Personal Spending (actual 0.4%; consensus 0.5%) report for August missed expectations, showing some moderation in the yr/yr core PCE rate to 3.9% from 4.3% in July. There is much uncertainty, a UAW strike, government shutdowns and margin deficiencies. Another underperformance in longer tenors expanded the 2s10s spread by 21 bps to -47 bps. For the month, the 2s10s spread expanded by 30 bps.

Crude oil pulled back from highs but still gained more than $7.00/bbl for the month, while the U.S. Dollar Index dipped 0.1% to 106.15, narrowing this week’s gain to 0.5%. The Index rose 2.4% in September.

Global “risk off” was not contained within the “periphery.”

  • Ten-year Treasury yields jumped 14 bps this week to 4.57%, the high back to October 2007.
  • Benchmark MBS yields surged 18 bps to 6.36%, trading Thursday at 6.50% for the first time since April 2002.
  • High yield CDS surged 35 to 481 bps, trading this week at highs since May.
  • U.S. bank CDS prices were at the top of the week’s global leaderboard. Bank of America CDS jumped 9.5 to a four-month high 96 bps. Citigroup CDS gained seven to a four-month high 86 bps, while JPMorgan CDS increased four to a four-month high 65 bps.

De-risking and deleveraging gained momentum this week, much to do with margin covering. Global yields spike with notable pain for the European periphery.

At Thursday’s highs (yields)

  • Italian 10-year yields traded to 4.95%, up 35 bps w-t-d to the high back to the 2012 European bond crisis.
  • Greek yields were up 33 bps w-t-d (4.52%) at Thursday’s highs,
  • Portuguese (3.75%) and Spanish (4.08%) yields 25 bps higher.
  • The spread between German and Italian 10-year yields widened nine this week to 194 bps, the widest level since the March banking crisis period.

A few of the higher risk headlines for prices:

  • UAW Strike News of the UAW continuing and intensifying strike actions against the Big Three automakers pressures markets. Global market “risk off” continues to gather momentum.
  • Margin Calls

Key Catalysts that empowered latest Treasury sell off:

“Based on projected intermediate- to long-term borrowing needs, Treasury intends to gradually increase coupon auction sizes beginning with the August to October 2023 quarter. While these changes will make substantial progress towards aligning auction sizes with intermediate- to long-term borrowing needs, further gradual increases will likely be necessary in future quarters.”

August 11 – Bloomberg (Farah Elbahrawy and Greg Ritchie): “US Treasuries are on course for a record year of inflows as investors chasing some of the highest yields in months pile into cash and bonds, according to Bank of America… Cash funds attracted $20.5 billion and investors poured $6.9 billion into bonds in the week through August 9… Meanwhile, US stocks had their first outflow in three weeks at $1.6 billion. Flows into Treasuries have reached $127 billion this year, set for an annualized record of $206 billion, BofA said.”

September 19 – Reuters (Rodrigo Campos): “Global debt hit a record $307 trillion in the second quarter of the year despite rising interest rates curbing bank credit, with markets such as the United States and Japan driving the rise, the Institute of International Finance (IIF) said… The financial services trade group said… global debt in dollar terms had risen by $10 trillion in the first half of 2023 and by $100 trillion over the past decade. It said the latest increase has lifted the global debt-to-GDP ratio for a second straight quarter to 336%. Prior to 2023, the debt ratio had been declining for seven quarters.”

Yield Watch

Friday/Week/Month

  • 2-yr: -4 bps to 5.04% (-8 bps for the week; +18 bps for the month)
  • 3-yr: -4 bps to 4.79% (-4 bps for the week; +16 bps for the month)
  • 5-yr: -4 bps to 4.60% (+3 bps for the week; +36 bps for the month)
  • 10-yr: -2 bps to 4.57% (+13 bps for the week; +48 bps for the month)
  • 30-yr: -2 bps to 4.71% (+19 bps for the week; +51 bps for the month)

Key Rates and Spreads

Rates

  • 10-year Treasury bonds 4.58%, up +0.15% w/w (2.60-4.58) (new 15 year high) (9/29/23 w/e)
  • Credit spread 1.81%, up +.09% w/w (1.72-2.42) (new 1 year low)
  • BAA corporate bond index 6.39%, up +0.24% w/w (1-yr range: 5.28-6.59) (10 year+ high)
  • 30-Year conventional mortgage rate7.44%, up +0.05% w/w (5.05-7.65) (new 23 year high intraweek). (9/29/23 w/e)

Yield Curve

  • 10-year minus 2-year: -0. 48%, up +0.20% w/w (1-yr range: -1.06 – 1.59) (new 40 year low)
  • 10-year minus 3-month: -0.88%, up +0.17% w/w (1-yr range: -1.69 – 2.04)
  • 2-year minus Fed funds: -0.27%, down -0.05% w/w.
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y)

Money Market Flows

  • Investment-grade bond funds posted outflows of $1.663 billion, and junk bond funds reported negative flows of $2.410 billion (from Lipper – data to be discontinued).
  • Total money market fund assets added $6.3bn to $5.644 TN, with a 29-week gain of $750bn (27% annualized). Total money funds were up $1.054 TN, or 23.0%, y-o-y.
  • Total Commercial Paper rose another $11.1bn to $1.195 TN. CP was down $35.4bn, or 2.9%, over the past year.

Bond auctions this week:

Softer Demand at 7-year Treasury Bond Auction Completes Week’s Offerings with Higher Yields
Solid Demand in 5-Year Treasury Auction Despite Continued Bond Selling
Treasury Auctions 2-year Notes at 5.024%, Part of $133 Billion Fresh Bond Supply This Week

Bond auctions week ahead:

Next week will bring some new supply.

  • Monday: 13- and 26-week bills
  • Tuesday: 
  • Wednesday: 17-week bills
  • Thursday: 4- and 8-week bills;

10 Year Note Technical Analysis via KnovaWave

Highlights – Federal Reserve

  • Federal Reserve Credit declined $23.3bn last week to $7.980 TN.
  • Fed Credit was down $921bn from the June 22nd, 2022, peak.
  • Over the past 211 weeks, Fed Credit expanded $4.253 TN, or 114%.
  • Fed Credit inflated $5.169 TN, or 184%, over the past 568 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt increased $2.0bn last week to $3.436 TN.
  • “Custody holdings” were up $70bn, or 2.1%, y-o-y.

Powell at the FOMC: “I guess it’s fair to say that the economy has been stronger than many expected, given what’s been happening with interest rates. Why is that? Many candidate explanations. Possibly a number of them make sense. One is just that household balance sheets and business balance sheets have been stronger than we had understood, and so that spending has held up and that kind of thing. We’re not sure about that.”

Federal Reserve Kept Rates at 22-Year High 5.25-5.50% Range as Expected

Highlights – Mortgage Market

  • Freddie Mac 30-year fixed mortgage rates jumped 12 bps to 7.35% (up 65bps y-o-y) – the high since December 2000.
  • Fifteen-year rates rose 11 bps to 6.79% (up 83bps) – the high since December 2000.
  • Five-year hybrid ARM rates declined six bps to 6.96% (up 168bps).
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates up 16 bps to 7.78% (up 96bps) – the high since November 2000.
Mortgage News Daily

Global Bond Watch

Higher for longer is a serious threat.

Global Yields Spiking Higher

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.

Emerging markets remain under de-risking pressure.

  • The Colombian peso declined 2.19%, the Brazilian real 1.93%, the Russian ruble 1.82%, the Mexican peso 1.27%, and the Polish zloty 1.15%.
  • For September, the Polish zloty dropped 5.68%, the Hungarian forint 4.60%, the Chilean peso 4.40%, the Czech koruna 3.93%, and the Thai Baht 3.88%.

EM bonds remain under significant pressure. Local currency yields surged 145 bps this week in Turkey (25.91%), 27 bps in Peru (7.32%), 23 bps in Hungary (7.49%), 14 bps in Indonesia (6.88%), and 11 bps in Brazil (11.66%).

EM dollar bond yields spiked higher. Yields jumped 21 bps in Colombia (8.21%), 18 bps in Panama (6.76%), 16 bps in Turkey (8.56%), 14 bps in Indonesia (5.82%), 13 bps in Saudi Arabia (5.47%), 12 bps Mexico (6.34%), 12 bps in Peru (5.95%), and 11 bps in the Philippines (5.46%).

Major Benchmark 10-year Bond markets

Bond Market Performance 2023

Major 10-year Bonds/Notes

Highlights – European Bonds

  • Greek 10-year yields jumped 16 bps to 4.34% (down 23bps y-t-d).
  • Italian yields surged 19 bps to 4.78% (up 8bps).
  • Spain’s 10-year yields rose 11 bps to 3.93% (up 42bps).
  • German bund yields gained 10 bps to 2.84% (up 40bps).
  • French yields rose 11 bps to 3.40% (up 42bps).
  • The French to German 10-year bond spread widened one to 56 bps.
  • U.K. 10-year gilt yields surged 19 bps to 4.44% (up 77bps).

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.

Highlights – Asian Bonds

  • Japanese 10-year “JGB” yields added two bps to 0.77% (up 34bps y-t-d).

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

Core PCE inflation Decelerated in August, Though Energy Prices Cause Concern
US Producer Prices Higher in August, Cost of Gasoline Surged 20%
Cost of Living Crisis Deepens as Consumer Inflation Rises +0.6% in August
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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Real Time Economic Calendar provided by Investing.com.

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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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