Bond Traders Weekly Outlook: Woeful Long Bond Auction and Powell Sets Tone

U.S. Treasuries U.S. Treasuries finished the week mixed with the long bond rebounding from Thursday’s slide after its woeful auction Thursday. The offering tailed by a record 5.3 bps with the lowest bid-to-cover ratio in nearly two years and lowest indirect takedown in two years. The long bond yield settled within a basis point of its 50-day moving average (4.728%). Shorter tenors extended this week’s show of relative weakness. Reports about a ransomware attack that crippled the Industrial and Commercial Bank of China’s access to the U.S. Treasury market on Thursday was just another worry for investors. This week’s underperformance in shorter tenors compressed the 2s10s spread by 12 bps to -42 bps. Crude oil lost another $3.57, or 4.4% this week, while the U.S. Dollar Index gained 0.8% this week.

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.

“Losses on longer-dated Treasuries are beginning to rival some of the most notorious market meltdowns in US history. Bonds maturing in 10 years or more have slumped 46% since peaking in March 2020… That’s just shy of the 49% plunge in US stocks in the aftermath of the dot-com bust at the turn of the century. The rout in 30-year bonds has been even worse, tumbling 53%, nearing the 57% slump in equities during the depths of the financial crisis.” October 4 – Bloomberg (Ye Xie):

Weekly Recap

U.S. Treasuries U.S. Treasuries finished the week mixed note with the long bond rebounding from Thursday’s slide after its woeful auction Thursday. The offering tailed by a record 5.3 bps with the lowest bid-to-cover ratio in nearly two years and lowest indirect takedown in two years. The long bond yield settled within a basis point of its 50-day moving average (4.728%). Shorter tenors extended this week’s show of relative weakness.

Fed Chair Powell sent a reminder this week:

“Federal Reserve chair Jay Powell has warned the US central bank against the risk of being ‘misled’ by good data on prices, saying the mission to return inflation to its 2% target had a ‘long way to go’. Speaking at an IMF event…, the Fed chair said officials were ‘gratified’ by the retreat in price pressures, but stopped short of sounding the all-clear on an inflation problem that has proved more persistent than policymakers expected. ‘We know that ongoing progress toward our 2% goal is not assured: inflation has given us a few head fakes… If it becomes appropriate to tighten policy further, we will not hesitate to do so.’” November 8 – Financial Times (Colby Smith):

Reports about a ransomware attack that crippled the Industrial and Commercial Bank of China’s access to the U.S. Treasury market on Thursday was just another worry for investors. This week’s underperformance in shorter tenors compressed the 2s10s spread by 12 bps to -42 bps. Crude oil lost another $3.57, or 4.4% this week, while the U.S. Dollar Index gained 0.8% this week.

Inflation is demonstrating unmistakable persistence, with Middle East instability posing a clear and present danger of higher crude prices being allayed for now. Though this appeares to be at the mercy of Mid-East war escalation. Moreover, an increasingly fragmented global economy elevates the risk of supply chain issues and resource scarcities.

US Treasury Issuance Plans

This past week’s Treasury announcements on marketable debt issuance and the Quarterly Refunding statements took the heat off some bond market fears. That said the real test comes in this coming week’s US Treasury auctions for 3s (Tuesday), 10s (Wednesday) and 30s (Thursday).

Treasury Funding Auction Sizes Increase, but Less Than Feared

A gauge of auction strength we keep our eye on is bid-to-cover ratios. These have recently weakened as bonds sold off). With this swift move in rates, we watch to see if the market chases lower yields with stronger bid-to-cover ratios. That could be more consequential than anything else in an otherwise lighter than usual week for data and news, that said the Fed speakers are back out in force.

This week’s response was in contrast to last time these announcements on July 31st and August 2nd contributed to the accelerated rise in US Treasury yields. Just ahead of that on the July 27th, the Bank of Japan tweaked its yield curve control parameters that prompted a selloff in Japanese government bonds with trickle over effects into Treasuries. The BoJ was up again this week also and created a flutter.

At that prior refunding the size of its quarterly bond sales increased for the first time since early 2021 and then Fitch downgraded the US government’s credit rating from AAA to AA+. More supply, negative ratings action, and voila yields took off.

On July 31st at 3pmET, the US Treasury announced that it had increased the estimated amount of privately held net marketable borrowing for Q3 to US$1.007 trillion which was well in excess of street estimates that had expected a reading in the high 700s or 800s. Two days later, that was accompanied by the Quarterly Refunding Statement (here) that said “Treasury anticipates incrementally increasing auction sizes across benchmark tenors” and backed that up with higher-than-expected auction sizes along with guidance that “further gradual increases will likely be necessary in future quarters.” – Scotiabank

It seems we were at least right about the reaction: Now this time it shouldn’t be a surprise, the question this time is how much of that expectation has already been priced in higher Treasury yields given the advance guidance. Logic suggests It would take even higher than expected issuance to shock markets.

US banks Preference Toward Maintaining Reserves Impact

There has been a continuation of US banks are showing a preference toward maintaining reserves over US$3T and in order to achieve this the banks are being forced to liquidate their Treasury holdings and hence drive yields higher. Earnings reports from JPM, WFC and C gave us further indication of this pattern.

Still treasury yields continued to move higher despite a growing sense that the bond and stock market are oversold in the short-term and due for a bounce.

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

  • 2-yr: +4 bps to 5.05% (+19 bps for the week)
  • 3-yr: +5 bps to 4.82% (+21 bps for the week)
  • 5-yr: +3 bps to 4.67% (+18 bps for the week)
  • 10-yr: UNCH at 4.63% (+7 bps for the week)
  • 30-yr: -4 bps to 4.73% (+2 bps for the week)

Key Rates and Spreads

Rates

  • 10-year Treasury bonds 4.62%, up +0.05% w/w (3.30-4.99) (new 15 year high 10/20/23 w/e)
  • Credit spread 1.71%, down -0.23% w/w (1.71-2.42) (new 1 year low 11/10/23 w/e)
  • BAA corporate bond index 6.33%, down -0.18% w/w (1-yr range: 5.28-6.80) (14 year+ high w/w 10/20/23)
  • 30-Year conventional mortgage rate 7.56%, up +0.18% w/w (6.07-8.03) (new 23 year high 10/20/23 w/e)

Yield Curve

  • 10-year minus 2-year: -0.43%, down -0.16% w/w (1-yr range: (-1.07 – -0.17) (new 40 year low)
  • 10-year minus 3-month: -0.80%, up +0.04% w/w (1-yr range: -1.89 – 0.21)
  • 2-year minus Fed funds: -0.28%, up +0.21% w/w.
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y)

Money Market Flows

  • Total money market fund assets gained $17bn to $5.712 TN, with a 35-week gain of $818bn (25% annualized).
  • Total money funds were up $1.091 TN, or 23.6%, y-o-y.
  • Total Commercial Paper surged $22.6bn to $1.241 TN. CP was down $55bn, or 4.2%, over the past year.

Bond auctions this week:

Woeful 30-year Treasury Bond Auction with Record 5.3 bps Tail Completes Week’s Offerings
U.S. 10-year Bond Auction Auctioned at 4.61%, Highest Yield at Auction Since 2007 Ahead of CPI
Dismal 3-year Bond Auction in Another Week of Heavy Supply Gets an F Rating

Bond auctions week ahead:

Next week will bring some new supply.

  • Monday: 13- and 26-week bills
  • Tuesday:  42-day cash management bills,
  • Wednesday: 17-week bills; 2-year floating rate notes;
  • Thursday: 4- and 8-week bills;

2-, 10- and 30-Year Treasuries Technical Analysis via KnovaWave

Highlights – Federal Reserve

  • Federal Reserve Credit declined $38.8bn last week to $7.822 TN.
  • Fed Credit was down $1.079 TN from the June 22nd, 2022, peak.
  • Over the past 217 weeks, Fed Credit expanded $4.095 TN, or 110%.
  • Fed Credit inflated $5.011 TN, or 178%, over the past 574 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt fell $7.6bn last week to $3.426 TN.
  • “Custody holdings” were up $88bn, or 2.6%, y-o-y.
Central Bank Watch – Week Ahead Focus on RBA and Powell Again

Powell at the FOMC: “So, obviously we’re monitoring, we’re attentive to the increase in longer-term yields and which have contributed to a tightening of broader financial conditions since the summer. As I mentioned, persistent changes in broader financial conditions can have implications for the path of monetary policy. In this case, the tighter financial conditions we’re seeing from higher long-term rates but also from other sources like the stronger dollar and lower equity prices could matter for future rate decisions, as long as two conditions are satisfied. The first is that the tighter conditions would need to be persistent and that is something that remains to be seen. But that’s critical, things are fluctuating back and forth, that’s not what we’re looking for. With financial conditions, we’re looking for persistent changes that are material.”

“So, I think what we can say is that financial conditions have clearly tightened, and you can see that in the rates that consumers, households and businesses are paying now, and over time that will have an effect, we just don’t know how persistent it’s going to be, and it’s tough to try to translate that in a way that I’d be comfortable communicating to how many rate hikes that is.”

Federal Reserve Kept Rates Unchanged; Eases Financial Conditions

Highlights – Mortgage Market

  • Freddie Mac 30-year fixed mortgage rates sank 37 bps to 7.35% (up 27bps y-o-y).
  • Fifteen-year rates dropped 28 bps to 6.79% (up 41bps).
  • Five-year hybrid ARM rates fell 18 bps to 7.03% (up 97bps).
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates down three bps to 7.89% (up 105bps).
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.

Major Benchmark 10-year Bond markets

Bond Market Performance 2023

Major 10-year Bonds/Notes

Highlights – European Bonds

  • Italian yields increased six bps to 4.58% (down 12bps).
  • Greek 10-year yields added two bps to 3.96% (down 60bps y-t-d).
  • Spain’s 10-year yields rose nine bps to 3.77% (up 26bps).
  • German bund yields increased seven bps to 2.72% (up 27bps). French yields gained six bps to 3.30% (up 32bps).
  • The French to German 10-year bond spread narrowed one to 58 bps.
  • U.K. 10-year gilt yields rose five bps to 4.34% (up 66bps).

Italy’s and the UK’s 10-year bond yields are the highest in the G7 after the U.S. 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 dropped eight bps to 0.85% (up 43bps y-t-d).

Key US Bond Auction Highlights

Woeful 30-year Treasury Bond Auction with Record 5.3 bps Tail Completes Week’s Offerings

U.S. 10-year Bond Auction Auctioned at 4.61%, Highest Yield at Auction Since 2007 Ahead of CPI

Dismal 3-year Bond Auction in Another Week of Heavy Supply Gets an F Rating

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

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