Financial basis

The US bond market announces that it is no longer a one-way street

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(Bloomberg) – US government debt traders received a stern reminder last week not to sleep in a market that has long been heading in one direction.

Yields had risen to the highest levels in years in anticipation of further interest rate hikes from the Federal Reserve and the central bank was beginning to shed Treasuries and bonds from its balance sheet by not replacing them at their deadline. For most of the first quarter, short-term yields paced the move.

While the tone had started to change this month, with long-term yields leading the latest move higher, a sharp drop in short-term yields mid-week left traders wondering if they were looking at a new trend or just a wave of gains. crop on the old. The reversal was accompanied by a plethora of large trades in related futures consistent with the profit lock.

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A weaker-than-expected increase in consumer prices in March excluding food and energy, reported on Tuesday, provided fundamental catalyst for bets that the Fed could end up raising rates less than currently expected as inflation eases. cools, allowing short-term yields to fall. But there is no consensus on the outlook for inflation, or the prospect of one in sight. Economic data is scarce next week.

“It’s a tough time right now for the bond market,” said Gregory Faranello, head of US rates trading and strategy for AmeriVet Securities. “Inflation is at extreme levels and we just don’t know to what level it is declining from the peak.”

Here’s how it rattled: The yield on the two-year note – more sensitive than longer-term yields to changes in the Fed’s key rate – fell to 2.27% on Thursday after the 2.60% high of this year on April 6. It ended the week around 2.45% after a sharp rebound on Thursday, when an import price gauge rose more than economists expected. US markets were closed on Friday.

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The slump in two-year yields represented some pushback from expectations for how big the Fed will raise rates this year, although a half-point hike at the next meeting in May is almost fully integrated with the corresponding futures contracts.

New York Fed President John Williams said Thursday it was “a reasonable option” as rates remain low. The quarter-point increase in March to 0.25%-0.5% was the first since 2018. Williams also said the underlying inflation trend will soon peak. Fed Chairman Jerome Powell is expected to attend an IMF event next week on Thursday.

TD Securities recommended buying three-year Treasury bills at yields close to 2.75%, anticipating a decline to 2.25%.

The idea is that if tighter monetary policy – ​​combined with pandemic containment measures and the global fallout from the Russian invasion of Ukraine – limits growth, the peak in rates could be lower and closer. provided that. Futures markets are currently pricing a peak of just over 3% in mid-2023.

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“It’s unclear what central banks will do when we end up with little growth and inflation above target,” Faranello said.

Longer-term yields continued to rise, with benchmark 10-year bonds hitting a high of 2.83% in 2022. It collided with a descending trendline that contained it for a generation. For some, it was confirmation that the four-decade bull run in bonds was ending – helped by the Fed’s decision to allow its portfolio to drain.

Read more: Treasury Yield Rise to Threaten Bull Run’s Latest Resistance Line

As the 30-year bond yield also hit year-highs on Thursday – 2.93% – the yield curve steepened, reversing the powerful curve-flattening trend that has defined the market over the past 12 months.

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The spread between two- and 10-year yields, which fell from a 2021 high near 162 basis points to -9.5 basis points on April 4 – the two-year exceeding the 10-year for the first times since 2019, has returned to 37 basis points.

The 5-30 year curve, which reversed on March 28 for the first time since 2006 and reached an extreme of -15.6bp on April 6, rebounded to 13 basis points.

“It’s healthy to see a steeper, more normally sloped curve after recent reversals,” said Jason Pride, director of private wealth investments at Glenmede. “The Fed wants to push the markets until there is a more negative reaction – especially in credit and equities – that slows the economy.”

Curve flattening, which normally takes place in anticipation of Fed rate hikes, started much earlier from the first hike than has happened historically, putting traders on alert about when the trend reversal might begin.

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JPMorgan Chase & Co. is among Wall Street firms that view the recent bout of steepening as a mere hiatus. Its US interest rate strategists recommended positioning for a flatter curve after the move. The call was based on anticipated demand from pension funds for long-dated debt as well as the limited impact of Fed balance sheet measures.

Bond traders expect a more contested market in the coming weeks. The stakes are high. The first quarter was the worst ever for the Treasury market, and the second got off to an inauspicious start.

What to watch

Economic calendar: April 18: NAHB housing index April 19: building permits/housing starts April 20: MBA mortgage applications; Sales of existing houses; Fed Beige BookApril 21: Philadelphia Fed Trade Outlook; applications for unemployment benefits; leading index April 22: S&P Global manufacturing/servicesFed calendar: April 18: St. Louis Fed President James Bullard April 19: Chicago Fed President Charles Evans April 20: San Francisco Fed President , Mary Daly; Evans21 April: Powell, President of the Fed, and Christine Lagarde, President of the ECB, during a panel on the world economy of the IMF. Reopening of 20-year bondsApril 21: 4- and 8-week notes; ADVICE 5 years

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