Rapid cash

Treasury market suspends rally as rising yields attract cash

After the persevering sell-off that started the year, buyers of longer-dated Treasuries are returning, providing respite from a market shaken by soaring inflation and a move toward tighter monetary policy. from the Federal Reserve. Benchmark 10-year yields have moved away from their most significant level since January 2020, pushed to a limited extent by foreign investors attracted by the peak in the first week of the year. A sale of $22 billion in 30-year Treasury bills on Thursday closed with virtually no reduction in winning yields.

The stabilization marks a welcome, if potentially temporary, break from what had been a rough start to the year for Treasuries due to growing belief that the Fed is about to start raising rates in March and begin to reduce its balance sheet by $8.8 trillion in the second half. This week’s pullback in yields reflects the view that the market has repriced too much, too quickly given the uncertain outlook, even though broad consensus rates will rise as the central bank pulls back the tide of liquidity it has been pumping since. the start of the pandemic.

Prices rose thereafter, pushing some yields down four basis points on the day as the selloff was seen as a key test of demand.

“The initial bearish bond euphoria seems to be fading,” said Ian Lyngen, head of US rates strategy at BMO Capital Markets. “But the combination of stability in other asset classes and further progress towards the first upside of the cycle will gradually embolden those anticipating higher returns.”

Fed Chairman Jerome Powell said this week that the central bank is ready to accelerate the pace of tightening if necessary, and some Fed officials have been pushing for the bank to reduce its bond holdings at a faster pace. .

The respite also likely reflects the central bank’s still-loose policy, which is expected to continue buying more bonds through March, even as consumer prices rise at the fastest annual rate since 1982 and wages rise. . At the same time, there are questions about whether a series of relatively shallow rate hikes will bring inflation down – or whether the Fed will find itself behind the curve, fighting a kind of price-wage spiral like the one that gripped the nation in the early 1980s.

The Fed’s trajectory would warrant a rally in 10-year yields above 2%, an area previously frequented in mid-2019. The benchmark yield climbed two basis points to 1.73% in early Asian trading on Friday.

‘Logic’

“A 10-year Treasury yield rising toward 2.25% makes sense, with the Fed indicating it will begin to tighten quickly this year,” said Jason Bloom, head of bond and alternative ETF strategies at Invesco. Based on the current level of historically low long-term yields, the bond market expects a rapid moderation in inflation and remains skeptical that the Fed will raise overnight rates well beyond that. 2% without triggering financial turmoil for a deeply indebted economy.

“The market thinks the Fed won’t raise rates past 2.5% without triggering a recession,” Bloom said. These expectations supported the buying of 10- and 30-year Treasuries this week after yields rose 1.51% and 1.90% at the end of December. Foreign demand is another supporting factor, as yields on long-term Treasuries are comfortably above those of their main sovereign rivals. Once the 10-year Treasury is hedged via the forex market, a European investor is left with a return of around 1%, “the most in five years,” Saxo Bank said in a research note this week.

Garry Evans, chief global asset allocation strategist at BCA Research, expects the Fed to make three quarter-point hikes this year, with the risk of a fourth, and play down the risk a faster tightening cycle. But he said a “price/wage spiral” would prompt more aggressive moves. “There is a risk that wages will rise and the Fed will start to worry,” Evans said, after which “the market will start pricing in a scenario where the Fed has lost control of inflation.”

Consensus challenge Such a reversal would challenge the current broad consensus that rate hikes primarily drive up short-term policy-sensitive yields, resulting in a flatter curve, as those for bonds at 10 and 30 years are increasing at a slower rate. But this reflects the traditional view that rate hikes will slow growth and inflation, which by no means seems assured given that rates will remain historically low even after the round of hikes expected this year.

“We won’t really know what inflation looks like and whether the Fed is behind the curve until the end of this year,” Invesco’s Bloom said. In the near term, the case for higher yields has room to grow once the excessively bearish positioning clears and some investors close trades to pocket the recent gains. Taking a negative view had become very crowded at the start of the week, with bearish net positions at their highest level since 2017, according to a survey by JPMorgan Chase & Co.

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  • Treasury market suspends rally as rising yields attract cash
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