On a calmer day for financial markets, it’s useful to take a step back to better understand what are the trends that are driving risk sentiment in the bond market. I can currently point to four main drivers of US Treasuries:
- Supply and demand
- Debt ceiling dilemma
- Inflation expectations
- Monetary policies’ expectations
The above can be used as a compass when analyzing the recent selloff in US Treasuries and it shows that the fast rise in yields can be attributed only by a shift in monetary policy expectations.
Supply and demand
This week the US Treasury sold 2-year, 5-year and 7-year notes and despite demand was slightly lower compared to summer, it was good enough not to spill volatility in the secondary market. Bidding metrics deteriorated considerably only for the 2-year notes, which might be linked to the debt ceiling dilemma. However, demand for the belly of the curve remained decent leading us to believe that the bear steepening of the yield curve has not been caused by supply-demand discrepancies
Debt ceiling dilemma
Discussions concerning the debt ceiling issues are taking a central stage as Janet Yellen said that the US might default on its debt already by the 18th of October, a date eerily close. However, the reaction to that news should be a bear flattening of the yield curve, not a bear steepening led by the belly of the curve as we have seen in the past few days. Indeed, a default would provoke short-term rates higher, while the long part of the yield curve, 10-year yields in particular, will drop serving as a safe-haven exactly as they did during previous Debt ceiling crisis.
Therefore, only the lack of demand for the 2-year note auction can be reconducted to the debt ceiling crisis, while the selloff throughout longer maturities cannot be linked to this topic.