There once were two gents, both named Bill Whose market views oft could be shrill Now Ackman and Gross Have waved adios To shorts, with positions now nil When others all learned of this action The bond market really gained traction So, does five percent In truth, represent The highs? Or is this a distraction?
It ought to be no surprise that the bond market had a significant hiccup yesterday after the 10-year yield finally breached the 5.0% level for the first time in more than 15 years given the market’s penchant to focus on big round numbers. However, as can be seen in the chart below, the response by traders and investors was dramatic as it appears many were waiting for that level to ‘buy the dip’ in bonds. As such, after climbing to a high of 5.025%, the market reversed sharply with yields falling nearly 20bps at one point, although they closed slightly off the lows.
Source: Tradingeconomics.com
Ostensibly, a key driver of this move was a Tweet by hedge fund manager Bill Ackman explaining he had covered his bond short positions. “We covered our bond short. There is too much risk in the world to remain short bonds at current long-term rates. The economy is slowing faster than recent data suggests.” Similarly, former bond king, Bill Gross, tweeted that he was buying bonds across the curve after calling for a recession in the 4th quarter (that’s now!). And that’s all it took to reverse a substantial portion of the recent sell-off in Treasuries. Perhaps more interesting was the fact that the ongoing normalization of the yield curve was not impacted much at all. Yesterday, the 2yr-10yr spread had fallen to -18bps and this morning it is -22bps, so not all that different.
The question, of course, is what can we expect going forward? The thing that continues to bother me is the ongoing supply question, and at what price will the Treasury be able to sell new bonds to price sensitive buyers rather than the Fed. Nothing has changed that part of the equation and until the Fed ends QT, let alone restarts QE (which I do expect at some point in the future), I continue to believe bond yields will trend higher. And this view considers the fact that some further economic slowing seems highly probable to me. However, the supply issue is going to continue to be the dominant feature going forward.
One other issue is the ongoing Israeli-Palestinian conflict and how that could evolve, with many talking heads concerned that growth in that conflict will result in demand for more safety. Certainly, the gold price has been a huge beneficiary of that situation with the barbarous relic having gained more than $120/oz in price since the attack while bond yields are actually higher by 6bps, even after yesterday’s sharp decline in yields. However, my experience indicates that after the immediacy of any conflagration, whether Russia in Ukraine, or even 9/11, market behavior tends to move off that narrative and back to whatever was deemed relevant before the news. I see no reason for this to be different, and before the attack, yields were rising on the supply story and robustness of the US economy. That is the narrative that needs to change to reverse bond yields.
So, is there going to be a change in that narrative soon? Well, depending on one’s view of the value of PMI data, the flash releases this morning were all pretty crummy with all of Europe and the UK remaining below the key 50.0 level and last night’s Australian and Japanese data also quite weak, although Japanese Services data did manage to hold above the 50.0 level. As well, German GfK Consumer Confidence fell to -28.1, down from last month and below consensus expectations, so perhaps some economic weakness is coming our way.
However, first, those are not US numbers and second, the US data has consistently shown hard data (NFP, Retail Sales, IP, etc.) firmer than any of the survey data. So, while there continues to be gloom and doom on people’s minds, their actions have not yet matched those views. Now, a case can certainly be made that the US hard data is all lagging and the current situation is far worse than those numbers imply, but the Fed is not going to respond to that story. As long as the hard data offers cover for the Fed to maintain their current policy stance as they fight inflation, they are going to do so.
Summing it all up leads me to believe that nothing has changed the big picture. While yesterday’s bond move was certainly exciting, the fact that one hedge fund manager took profits is not enough to change the investment landscape. I continue to expect stickier inflation going forward as well as a grind higher in 10yr yields as the curve normalizes.
So, how did markets respond to all the new information? Well, after a mixed day in the US yesterday, we saw a similar picture in Asia with the Hang Seng falling -1.0%, but most other markets edging a bit higher. European bourses are slightly firmer this morning, but really no great shakes and US futures at this hour (8:30) are firmer by 0.6% or so. Fear is not that evident today.
On the bond side, this morning has seen a modest bounce in US yields, just 2bps, but we are seeing a continuation lower in Europe with most sovereigns seeing yields fall about 2bps. JGBs have also edged away from their recent high in yields, although that was after the BOJ had yet another unscheduled bond buying session, this one the largest of the five unscheduled ones so far implemented after they adjusted the YCC cap to 1.00%.
On the commodity front, oil is essentially unchanged this morning although that is after a sharp decline yesterday which wiped out the previous week’s gains. Gold, while still holding up reasonably well, is softer by -0.4% this morning and copper is bucking this trend, rising 0.6%, although still hovering just above 1yr lows.
Finally, the dollar, which fell yesterday a bit as yields decline sharply in the US, is bouncing this morning with the euro sliding back toward 1.06 and the DXY back at 106.00. Neither JPY nor CNY really responded to yesterday’s price action, it was mostly European currencies doing the damage to the buck. One thing to note is the question of whether the 10-year yield is still a key driver of the dollar or is it something else? Brent Donnelly, a well-respected FX analyst, has an excellent article out discussing how the dollar appears to be more linked to the 2-year yield than the 10-year. I had mentioned last week how that relationship between the dollar and yields seemed to be breaking down and his analysis shows that if you look at the 2yr yield, which hasn’t moved much at all compared to the 10yr lately, it makes more sense. It is well worth the read.
With that in mind, then perhaps the dollar’s strength is unlikely to manifest itself as it did while the Fed was aggressively raising rates earlier in the year and 2yr yields were rising rapidly. Instead, it is quite possible we are in for a period of relative quietude in the dollar, at least against the majors. Emerging market currencies have a clear life of their own, and hedging decisions there need to be independent of views on the euro or pound.
On the data front, the Flash PMI’s are due here as well (exp 49.5 Manufacturing, 49.8 Services) and then the first look at oil inventories late this afternoon. Interestingly, despite the Fed’s ostensible quiet period, Chairman Powell will be making Introductory Remarks at the 2023 Moynihan Lecture in Social Science and Public Policy tomorrow at 4:30pm. Given the quiet concept, I find it difficult to believe he will focus on monetary policy but be aware.
All signs point to a quieter session today and perhaps for a while going forward, at least in the G10 currencies. However, hedging is always a good idea!
Good luck
Adf
fxpoetry 