Bond Market Veers From Historic Rallies to Record-Smashing Sales

By May 10, 2020, 7:00 AM EDT

  • Push-and-pull of supply, Fed demand seen fueling steeper curve
  • Powell set to speak on economy as reopening raises trepidation

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With the economy in freefall, bond investors are clinging to just two certainties right now: that the Treasury is flooding the market with debt, and the Federal Reserve is fully mobilized.

The government is about to raise a record $96 billion in its refunding auctions for stimulus in the wake of the pandemic. Traders will absorb this and any guidance from Fed Chair Jerome Powell on Wednesday, with the market already starting to hedge the risk of negative rates. These fiscal and monetary forces are driving yields at either end of the curve wider apart. The two-year is near a record low barely above zero, while the imminent reintroduction of 20-year bonds is helping drive up long-end rates.

Many investors see the curve steepening further. Indeed, it’s been billed the new consensus trade. One key reason: Supply pressures are only expected to build as the deficit heads toward $4 trillion. And the Fed, while promising to keep rates near zero to help revive growth, is continuing to reduce the pace of its Treasuries buying.

“The focus is all on reopenings so we will be sensitive to that, but since that will take some time to know, it’s all about Treasury supply and Fed demand,” said Priya Misra, a global rates strategist at TD Securities, which also favors a steepener.

Record auctions seen driving curve steeper

Two-year yields enter the week at 0.16%, not far above the record low touched Friday amid bets that the Fed could drop its benchmark rate below zero in 2021. Five-year rates also sank to unprecedented levels Friday, at 0.27%, and are about 105 basis points below the long-bond yield. That gap is the widest since March.

Traders Ask ‘Why Now?’ After Negative Rates Persist in Futures

A growth outlook this dire would ordinarily encourage investors to scoop up long-dated government debt. Friday’s labor report showed 20.5 million Americans lost jobs in April, tripling the unemployment rate to the highest since the 1930s. Data this week are projected to show 2.5 million more people filed for jobless claims.

Duration Risk

But at least temporarily, buyers may be overwhelmed by a slew of duration risk this month — a “big-time record,” according to Ian Burdette, head of term trading at Academy Securities.

With rates this low and the addition of the 20-year, he estimates the potential combined dollar value of risk across the four upcoming coupon auctions — of 3-, 10-, 20- and 30-year debt — is more than $140 million per basis point of yield. That’s almost double the increment implied in last quarter’s fundraising. He reckons the 30-year yield could revisit 2%, from 1.38% now.

This week will also likely bring more talk of reopening the economy, which might lead some investors to conclude the worst of the crisis is over.

Michael Crook, head of Americas investment strategy at UBS Global Wealth Management, says the current floor in yields won’t hold if attempts to open back up go poorly.

“Two to four months down the road, if it becomes clear the economic impact is going to be much more severe, we could retest those lows but also possibly see even lower rates,” said Crook.

What to Watch

  • Fed officials have a busy day Tuesday, and traders will watch for any pushback on negative-rates bets then, and on Wednesday from Powell:
    • May 11: Atlanta Fed’s Raphael Bostic discusses response to the pandemic
    • May 12: St Louis Fed’s James Bullard on the economic outlook; Minneapolis Fed’s Neel Kashkari on the economy; Philadelphia Fed’s Patrick Harker on the impact of Covid-19; Vice Chair Randal Quarles before Senate Banking Committee; Cleveland Fed’s Loretta Mester in Q&A
    • May 13: Powell discusses current economic issues
    • May 14: Kashkari, Dallas Fed’s Robert Kaplan
  • The economic calendar:
    • May 12: NFIB small business optimism; consumer price index; real average earnings; monthly budget statement
    • May 13: MBA mortgage applications; producer price index
    • May 14: Import/export prices; jobless claims; Bloomberg consumer comfort
    • May 15: Retail sales; Empire manufacturing; industrial production; capacity utilization; Bloomberg U.S. economic survey; business inventories; JOLTS job openings; University of Michigan sentiment; Treasury International Capital flows data
  • Auction calendar:
    • May 11: 13-, 26-week bills; $42 billion of 3-year notes
    • May 12: $35 billion of 119-day cash management bills; $65 billion of 42-day CMB; $32 billion of 10-year notes
    • May 13: $22 billion of 30-year bonds
    • May 14: 4-, 8-week bills


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