(Bloomberg) – US Treasury traders were given a stern reminder last week not to sleep in a market that has been moving in one direction for a long time.
Most read by Bloomberg
Yields had risen to their highest levels in years on anticipation of further interest rate hikes from the US Federal Reserve and the central bank, which began taking Treasury bills and bonds off its balance sheet by not replacing them when they mature. For most of the first quarter, short-term yields drove the move.
While sentiment began to shift this month and long-term yields led the recent move higher, a sharp fall in short-term yields midweek left traders questioning whether they were anticipating a new trend or just a string of gains. Harvest on the old. The reversal was accompanied by a plethora of large trades in related futures contracts to accompany the profit lock.
A lower-than-expected hike in March consumer prices excluding food and energy, reported Tuesday, provided a fundamental catalyst for bets that the Fed may hike rates less than currently expected if inflation cools, pushing short-term yields lower. But there is no consensus on the inflation outlook or the prospect of one in sight. Economic data is sparse next week.
“It’s a difficult time for the fixed income market right now,” said Gregory Faranello, head of US rates trading and strategy at AmeriVet Securities. “Inflation is at extreme levels and we just don’t know what level it will fall to from its peak.”
Here’s how it looked: The yield on the two-year note — more sensitive than longer-dated yields to changes in the Fed’s interest rate rate — fell as low as 2.27% on Thursday from its peak this year of 2.60% on April 6. It ended the week at around 2.45% after a strong rebound on Thursday, when a measure of import prices rose more than economists had expected. US markets were closed on Friday.
The story goes on
The impotence in two-year yields represented some moderation of expectations about how much the Fed could hike rates this year, even with a half-point hike at the next meeting in May almost entirely priced into related futures contracts.
New York Fed President John Williams said Thursday it was “a sensible option” as interest rates remain low. March’s quarter-point rise to 0.25%-0.5% was the first since 2018. Williams also said the underlying inflation trend will soon peak. Fed Chair Jerome Powell is scheduled to attend an IMF event on Thursday next week.
TD Securities recommended buying three-year Treasuries at yields near 2.75% and expected a drop to 2.25%.
The reasoning is that if tighter monetary policy – combined with measures to contain the pandemic and the global fallout from the Russian invasion of Ukraine – limits growth, the peak in interest rates could be lower and closer than previously expected. Futures markets are currently pricing in a peak of just over 3% in mid-2023.
“It’s not clear what central banks will do if we have low growth and above-target inflation,” Faranello said.
Yields at longer maturities continued to rise, with the benchmark 10-year bond peaking at 2.83% in 2022. It collided with a downward sloping trend line that has contained it for a generation. For some, it was confirmation that the four-decade bull run in bonds is coming to an end – aided by the Fed’s move to phase out its portfolio.
Read more: Rise in Treasury yields threatens last Bull Run resistance line
As the yield on the 30-year bond also hit its highest level for the year – 2.93% – on Thursday, the yield curve steepened, reversing the strong flattening trend that has characterized the market over the past 12 months.
The gap between 2-year and 10-year yields, which narrowed to -9.5 basis points on April 4 from a peak in 2021 near 162 basis points – with 2-years outstripping 10-years for the first time since 2019, narrowed to 37 base points.
The 5-30 year curve, which inverted on March 28 for the first time since 2006 and reached an extreme of -15.6 basis points on April 6, recovered to 13 basis points.
“It’s healthy to see a steeper, more normally sloped curve after recent inversions,” said Jason Pride, chief investment officer of private wealth at Glenmede. “The Fed wants to rush markets until there is a more negative reaction — particularly in credit and stocks — that slows the economy.”
The curve flattening, which usually unfolds in anticipation of Fed rate hikes, started much earlier compared to the first rate hike than in the past, making traders nervous about when the trend reversal might begin.
JPMorgan Chase & Co. is among those Wall Street firms that are viewing the recent rally as nothing more than a pause. Its US interest rate strategists recommended positioning for a flatter curve after the move. The request was based on expected demand from pension funds for long-term debt, as well as a limited impact of the Fed’s balance sheet measures.
Bond traders expect a more competitive market in the coming weeks. It’s about a lot. The first quarter was the worst ever for the Treasury market and the second got off to a bad start.
Something to see
-
Economic calendar:
-
April 18: NAHB Housing Index
-
April 19: Building permits/housing start
-
April 20: MBA Mortgage Applications; existing house sale; Fed beige book
-
April 21: Philadelphia Fed Business Outlook; unemployment claims; leading index
-
April 22: S&P Global Manufacturing/Services
-
-
Fed calendar:
-
April 18: St. Louis Fed President James Bullard
-
April 19: Chicago Fed Chairman Charles Evans
-
April 20: San Francisco Fed Chair Mary Daly; Evans
-
April 21: Fed Chair Powell and ECB President Christine Lagarde at an IMF World Economic Panel
-
-
Auction calendar:
-
April 18: 13, 26 week bills
-
April 19: Bills for 52 weeks; Reopening of the 20-year bond
-
April 21: 4-, 8-week bills; 5 year TIPS
-
Most Read by Bloomberg Businessweek
©2022 Bloomberg LP
Comments are closed.