A guide into Treasuries as we are approaching the US election
Senior Fixed Income Strategist
Summary: Technical analysis shows that there is space for the US yield curve to flatten amid the US election. However, in the long-term, only a steepening is possible with the 30-year Treasury yields leading the way. The Fed will need to decide soon whether expanding its bond purchasing programme over long-term maturities to avoid a fast steepening of the yield curve.
Even though yesterday the market was a red sea with US equity indices falling around 3.5%, the bond market saw US Treasury yields barely moving. The front end of the yield curve 2s10s was stable while the 5s30s steepened slightly by one basis point. The US Treasury yesterday was able to sell $55bn of 5-year government bonds at a yield of 0.33%, which was 0.5% below the market's expectations. Investors' participation in the auction is key to understanding the prevailing sentiment in the bond market. The bid-to-cover ratio was below the 1-year average, and more than 60% of the notes were awarded to indirect bidders. This means that while foreign demand continues to drive US Treasuries performance, domestic government bond demand is slowing down amid the US election and the reflation story.
To understand how US Treasuries will perform going into the US election week, we can analyze the part of the yield curve that is currently being most active: the 5s30s.
This year, the long part of the yield curve is steepening faster compared to what we have seen from the second half of 2018 until the beginning of this year. The 5s30s spread is trading in an ascending wedge which has tested already twice. It would not be surprising to see the spread trying the support line as we get closer to the election. If the support line is broken, we can see the spread finding the first level of support at 109.30.
At present, long term yields are the biggest movers of the US yield curve. Thus, movements in 30-year yields are critical to understanding the yield curve direction.
Below you find a candle chart of the 30-year Treasury yield since the beginning of the year until today. As you can see, the 30-year yield broke above what it used to be its resistance line. The new support line has already been tested twice. As the election approaches and we experience more volatility in the equity market, it will most likely be tested again. If risk-off sentiment pushes yields below the support line, the 30-year yields will find support at 1.42%.
Even though we can see a slight flattening of the yield curve in the short term, in the long-term, some elements point to the fact that only a steepening of the yield curve is possible.
As the graph below shows, sentiment over US Treasuries has deteriorated since the beginning of the year until today. However, Treasury yields didn't rise because of recent risk-off trading dynamics. We expect this to change as reflation becomes a more threatening factor after the US election, especially if Biden wins.
Investors are increasing their short positions in US Treasury futures as reflation becomes a real threat. 30-year Treasuries are falling faster compared to 10-year Treasuries because the Federal Reserve accommodative monetary policies control the front part of the yield curve. Suppose the Fed doesn't want Treasury yields to rising fast after the elections. In that case, it may need to expand its bond purchasing programme to longer-term maturities.
Latest Market Insights
Q4 Outlook 2022: Winter is coming
- Winter is coming to the financial markets as central banks are tightening their grip. How spring will look is still a question.
European energy crisis: it will get worse before it gets betterThe winter in Europe will be tough, but whether the result is political chaos or sustainable, innovative solutions is still undecided.
A difficult and volatile quarter awaitsAs the year draws to an end, commodities continue to be at centre stage of the world with growth pockets political uncertainty.
The bright side: crises drive innovationThe positive spin on crises is that they come with solutions. It is worrisome that deglobalisation may be a response to this crisis.
Green transformation in China: renewable energy and beyondGoing green, China needs to span numerous energy sources to ensure stability, as every source comes with a challenge.
Asia: Intermittent solutions, but a faster renewable adoption curveAsian energy supply is being squeezed. This and the adoption of renewables may change the investment sentiment in the region.
FX: A Fed thaw needed to deliver a sustained USD turn lowerThe US Dollar can keep momentum when the Federal Reserve continues to tighten, leaving the rest to play to their drum.
Autumn can become ugly for equities and bond holders. Comfort for Dollar longsTechnical analysis suggests that equities could face a tough Q4 as could fixed income. US Dollar positions could provide some upside.
The next stock market sector to watch, with stocks going nuclearAs the world scrambles to find affordable, sustainable energy, nuclear is getting attention from politicians and investors alike.
The crypto space is getting cold when the hype disappearsCryptocurrencies face a winter of their own as retail investors and governments are asking tough questions.