Bond Traders Weekly Outlook: Yields Rise into Year End

U.S. Treasuries closed out 2022 with higher yields across the curve. The 10-yr note yield held under 3.90%, and the 2s10s inversion remained at 54 basis points. The 2-yr note began the year at 0.73% and settled at 4.42% on the last trading day of 2020, up five basis points. The 10-yr note began the year at 1.51% and closed out the year at 3.88%, up five basis points. For the month ten-year Treasury yields rose 27 bps to seven-week highs. Of note ten-year Italian yields ended the year at 4.70%, up 83 bps for the month of December to the high since October. Ahead we have Fed minutes in week one, where it all started in 2022.

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. A Bloomberg headline is insightful, “Bond Traders Dismiss Fed’s Hawkish Tone, Bet on 2023 Rate Cuts.”

Weekly Recap

A quiet end to the year. We can reflect to the brutal damage in the bond market in 2022. There were two U.S. Treasuries auctions last week, a $35 billion 7-yr note auction, the fixed interest desk rated the auction a C. The treasury also auctioned $43 billion 5-yr notes, the fixed interest desk rated the auction a C.

A time to reflect back to September, the eye of the storm for the bursting global bond bubble. UK gilt yields spiked 146 bps in the six sessions from September 16th to 27th to a 16-year high 4.59%. The catalyst was the new Truss government’s “mini budget” which heavy on tax cuts and spending. The markets changed their tune and wrecked the pound and gilts leading to the end of Truss in record time. Surging inflation, powerful global deleveraging, and liquidity drying up saw a market reaction that was brutal.

While hedge funds and other specs helped the cause, deleveraging in the UK pension system was perfectly described in September as the epicenter of bond market dislocation. So-called “liability-driven investing,” or LDI, had in the UK tripled in size over the past decade to $1.7 TN (from Bloomberg). These strategies accumulated huge amounts of leverage and derivatives, with surging market yields sparking self-reinforcing liquidations, higher yields and more forced liquidations. It was one massive, self-reinforcing margin call, not just in the UK, but globally.

Contagion effects were powerful. Greek yields surged 60 bps in six sessions to a five-year high 4.84%, with Italian yields up 62 bps to an almost decade-high 4.64%. Ten-year Treasury yields surged 57 bps in seven sessions to an intra-day high of 4.01% on Wednesday, September 28th – trading above 4% for the first time since 2008. The U.S. bond volatility MOVE index surged to about 160, just below the March 2020 crisis high. U.S. corporate CDS (investment-grade and high-yield) spiked to the highest prices since the 2020 pandemic crisis. During UK crisis week, 10-year yields surged 73 bps in Poland, 62 bps in Croatia, 52 bps in Hungary, 43 bps in the Czech Republic, and 41 bps in Peru.

China’s “big four” bank CDS surged to multi-year highs. China sovereign CDS posted a two-week 37 bps spike to 112 – the high back to January 2017. With developer bond prices collapsing, the yield on China’s high-yield dollar bond index jumped over 200 bps in a week to 25.25%. Asian high-yield bond yields rose 133 bps to 17.54%.

Global bank CDS spiked higher. U.S. bank CDS prices jumped to highs since the pandemic. EM CDS surged. Dollar-denominated EM bond yields spiked higher. In short, highly synchronized world markets were at the brink. Markets were “seizing up” – and doing so in an environment with newfound central bank liquidity backstop (i.e. “Fed put”) ambiguity.

Yield Watch

  • 2-yr: +5 bps to 4.42% (+10 bps for the week… +369 bps for the year)
  • 3-yr: +6 bps to 4.24% (+15 bps for the week… +328 bps for the year)
  • 5-yr: +4 bps to 4.00% (+15 bps for the week… +274 bps for the year)
  • 10-yr: +5 bps to 3.88% (+13 bps for the week… +237 bps for the year
  • 30-yr: +5 bps to 3.97% (+15 bps for the week… +207 bps for the year)
  • Investment-grade bond funds posted outflows of $2.316 billion, while junk bond funds reported inflows of $103 million (from Lipper).
  • Total money market fund assets rose $22.2bn to $4.735 TN. Total money funds were up $30bn, or 0.6%, y-o-y.
  • Total Commercial Paper fell $17.3bn to $1.261 TN. CP was up $174bn, or 16.0%, over the past year.

Key Rates and Spreads

Rates

  • 10-year Treasury bonds 3.88%, up +0.13 w/w (1-yr range: 1.40-4.22) (12 year high)
  • Credit spread 1.96%, up +0.05 w/w (1-yr range: 1.65-4.31)
  • BAA corporate bond index 5.84%, up +0.18 w/w (1-yr range: 3.13-6.59) (10 year+ high)
  • 30-Year conventional mortgage rate6.54%, up +0.22% w/w (1-yr range: 2.75-7.38) (new 20 year high)

Yield Curve

  • 10-year minus 2-year: -0.55%, up +0.03% w/w (1-yr range: -0.85 – 1.59) (new 40 year low)
  • 10-year minus 3-month: -0.50%, up +0.08% w/w (1-yr range: -0.82 – 2.04) (new low)
  • 2-year minus Fed funds: 0.10%, up +0.10% w/w
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y)

10 Year Note Technical Analysis via KnovaWave

Key Bond Auctions

Highlights – Mortgage Market

  • Freddie Mac 30-year fixed mortgage rates jumped 21 bps to 6.41% (up 330bps y-o-y).
  • Fifteen-year rates surged 30 bps to 5.80% (up 347bps).
  • Five-year hybrid ARM rates jumped 23 bps to 5.62% (up 321bps).
  • Bankrate’s survey of jumbo mortgage borrowing costs had 30-year fixed rates up two bps to 6.59% (up 336bps).
Mortgage News Daily November 4, 2022

Highlights – Federal Reserve

  • Federal Reserve Credit declined $4.9bn last week at $8.526 TN.
  • Fed Credit was down $375bn from the June 22nd peak.
  • Over the past 172 weeks, Fed Credit expanded $4.799 TN, or 129%.
  • Fed Credit inflated $5.715 Trillion, or 203%, over the past 529 weeks.
  • Fed holdings for foreign owners of Treasury, Agency Debt were up $9.4bn last week at $3.318 TN.
  • “Custody holdings” were down $95bn, or 2.8%, y-o-y.

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)

Highlights – European Bonds

  • Greek 10-year yields gained six bps to 4.57% (up 325bps during 2022).
  • Italian yields surged another 21 bps to 4.72% (up 354bps).
  • Spain’s 10-year yields jumped 19 bps to 3.66% (up 310bps).
  • German bund yields rose 17 bps to 2.57% (up 275bps).
  • French yields gained 18 bps to 3.12% (up 292bps).
  • The French to German 10-year bond spread widened about one to 55 bps.
  • U.K. 10-year gilt yields increased four bps to 3.67% (up 270bps).

Highlights – Asian Bonds

  • Japanese 10-year “JGB” yields gained four bps to 0.42% (up 35bps for 2022)

Bond Market Performance 2022

Major Benchmark 10-year Bond markets

10 Year Bonds – Americas 2022 Performance

10 Year Bonds – Europe 2022 Performance

10 Year Bonds – Asia 2022 Performance

10 Year Bonds – Africa 2022 Performance

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.


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