Long-term US Treasuries remain supported by growth fears
Senior Fixed Income Strategist, Saxo Bank Group
Summary: Yesterday's solid 20-year US Treasury auction shows that real money continues to bet on weaker global growth and inflation expectations, which can come together with a significant risk-off event. However, we expect long-term yields to rise as the Federal Reserve begins its interest rate hiking cycle. Even if the central bank returns to its accommodative stance shortly after, there is the chance that inflation will remain a problem, requiring aggressive monetary policies in the future. Therefore, we see considerable downside potential for long-term Treasuries.
Yesterday’s 20-year auction was the last long-term bond sale of the year. It had all the elements to ignite a selloff in the long part of the yield curve, but it didn't. It rescued long-term bonds in a day of intense bear-steepening.
Before the bond sale, the US yield curve followed the steepening trend of its European counterparts. Long-term yields rose rapidly as interest rate hiking expectations advanced in the UK, with the OIS curve currently pricing a 21bps rate hike already by February. A second rate hike in the UK will allow the BOE to begin winding down its balance sheet. Such a move implies higher yields across the whole yield curve. Hence, the steepening.
Twenty-year US Treasury yields rose by 7bps ahead of the auction. Everything pointed to a weak bond sale as this tenor usually is not loved, and the market is illiquid amid Christmas. However, stronger than expected investors’ demand reverted losses in the long part of the yield curve. The bid-to-cover rose to 2.59x, the highest since June 2020, while primary dealers were left with a record low of 14.3%. The auction stopped through the WI by 2.3bps pricing with a high yield of 1.942%.
It is another confirmation that the market is betting on weaker global growth and inflation expectations, which might have a significant risk-off event in the stock market. Within this scenario, long-term bonds serve as a “crash insurance" on the economy, and real money is not afraid to increase its position in this part of the curve.
Yet, the long part of the yield curve rally might not last beyond the first quarter of 2022. As the Federal Reserve finishes taper purchases under its QE program, the beginning of a tightening cycle will become nearer, and a rise in yields across the whole curve will be unavoidable. As the chart below shows, 10-year yields have always shifted higher during previous interest rate hiking cycles. It’s prudent to assume that the same thing will happen this time around.
There is another thing to consider: inflation remains an underestimated threat. If the central bank returns to its accommodative stance due to a market selloff soon after it embarks on a tightening journey, there is the chance that inflation might rise even further. In that case, the Fed won’t have any other alternative rather than continuing hiking interest rates.
Latest Market Insights
Outrageous Predictions 2023: The War Economy
- The constantly growing global need for energy drives the world's richest to huddle up and launch a R&D project in a size the world hasn't seen since the Manhattan Project gave the US the first atomic bomb.
French President Macron resignsThe political stalemate in France and the rise of Marie Le Pen following the 2022 elections corners President Macron, forcing him to give up on politics and resign from his position. At least for now.
Gold rockets to USD 3,000 as central banks fail on inflation mandateAs markets and central banks realise that the idea that inflation is transitory is wrong, and that prices will remain higher for longer, gold is sent through the roof, hitting a price tag of USD 3,000
EU Army forces EU down path to full unionWith continued challenges in the region and a US military that isn't aggressively enacting its former role as global policeman, the European Union agrees to create its own armed forces, bringing the whole region closer.
A country agrees to ban all meat production by 2030In an effort to become one of the global leaders on the path to net-zero emissions, one country decides to not only put a heavy tax on meat, but to ban domestic production entirely.
UK holds UnBrexit referendumFollowing a recession and domestic pressure, the United Kingdom is thrown into political turmoil that will end with a vote to wind back Brexit.
Widespread price controls are introduced to cap official inflationHistory tells us that with the war economy comes rationing and price controls. And this time is no different, as policymakers introduce strict price controls that lead to a range of unintended consequences.
OPEC+ & Chindia walk out of the IMF, agree to trade with new reserve assetSanctions against Russia have caused widespread turmoil due to US Dollar moves in countries across the globe that don't consider the US an ally. To relieve themselves from this, they leave the IMF and create a new reserve asset.
USDJPY fixed to the USD at 200 as Japan overhauls financial systemFollowing the challenges that faced the Japanese Yen in 2022, the Bank of Japan attempts to keep the currency from sliding. Unsuccessful on the long-term, Japan will launch a reset of its entire financial system.
Tax haven ban kills private equityWith the war economy comes an increased focus on national interests and sovereign nations' ability to assert themselves. In that regard, the OECD countries turn their attention on tax havens and pull the big guns out, banning them altogether.
Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)