Fixed income chart pack for January
Senior Fixed Income Strategist
Summary: US Treasury yields have broken above key resistance levels. We expect them to continue to rise and the yield curve to bear-flatten as the Federal Reserve gets ready to tighten the economy. Accelerating real yields show that financing conditions are rapidly tightening. It spells trouble for risky assets, which despite remaining supported by deeply negative real yields, they'll suffer as TIPS approach 0%. Currently, duration is more toxic than credit quality, with investment-grade corporates and hard currency EM government debt paying the highest price.
Ten-year US Treasury yields are heading towards 2% amid market expectations of an aggressive Federal Reserve this year. Yet, the more aggressive the central bank is, the slower the future growth, compressing the rise of long-term yields. We expect an acceleration in long-term yields if the Fed engages in Balance sheet policies.
Two-year US Treasury yields broke above the pivotal 1% level. They are now in a fast area where they could rise rapidly to 1.40%, finding weak resistance at 1.3%.
As a consequence, the yield curve continues to bear flatten. The 5s30s spread is close to test resistance at 50bps.
Balance sheet policies will need to come into play. To tighten the economy more efficiently, the Fed might consider combining rate hikes with its balance sheet runoff. That way, the Fed will avoid the yield curve to flatten further, and lift long-term rates. Because the long part of the yield curve is responsible for borrowing and mortgages costs, the central bank will be more effective at tightening the economy. At the same time, it might not need to hike rates as aggressively as the market is currently forecasting.
The market might be ahead of itself in pricing over four interest rate hikes this year.
US Treasuries’ appeal will increase as yields rise. EUR hedged 10-year US Treasuries are paying more than 100bps, the highest in five years.
The acceleration in real yields should begin to worry stocks and corporate bonds’ holders. Ten-year real yields rose by 50bps since the beginning of the year. The closer they get to 0%, the tighter the financing conditions, posing a threat for risky assets. Troubles might start when real yields will break above -0.5%.
Bond Futures (Courtesy of Kim Cramer).
US 10 years T-Note has broken strong support at 127 29/32 – with ease. On the weekly the time period the future is well below 200 SMA, RSI has broken the rising trend line. Currently there is divergence as the RSI was lower in March 2021 indicating divergence but further selling can take that level out. Some support at around 126 22/32.
Monthly. the 200 SMA and the long term rising trend line will offer some support but it is a bit far away coming up around 125. RSI on Monthly chart is below 40 threshold indicating bearish sentiment.
After breaking bearish out of the symmetrical triangle the US T-Bond is now testing support at around USD153. If the bond closes the week below there is no strong support before 144. 144 is also around the 138.2% projection of the Shoulder-Head-shoulder pattern currently unfolding.
The US Ultra T-Bond has broken below support at 187 15/32. Next strong support is at around 180 15/32 which is also the Neckline int eh Shoulder-Head-Shoulder like pattern. The Ultra T-bond has broken the longer term rising trend line indicating a test of the 180 15/32 support is likely.
Ten-year Bund yields broke above 0% for the first time since May 2019. We expect yields to continue to rise as rates rise in the US, the ECB gradually withdraws stimulus and the German government increases fiscal spending.
It spells troubles for European sovereigns with a high Beta, such as Italian BTPS. We forecast the BTP-Bund spread to widen up to 160bps due to volatility in global rates. Concerns regarding the political scenario might further widen the spread above 200bps if Draghi takes on the role as president of the Republic forcing the country into early election.
Italian sovereign yields are rising. Ten-year yields broke resistance at 1.30%, entering in a fast area which could take them quickly to 1.50%.
2013’s taper tantrum shows that an acceleration in real yields provoked the selloff in risky assets. Despite real rates remain in deep negative territory, their recent acceleration suggests that we might soon see weakness among lower-rated credits as real yields get closer to 0%.
Until then, the real villain will be duration. Since the beginning of the year, assets carrying high duration has plunged fast. The higher the credit quality, the higher the duration.
Regardless, investors are beginning to exit junk. This month, the iShares iBoxx High Yield Corporate Bond ETF (HYG) suffered the worst exodus since September 2020, while the iShares Broad USD Investment Grade Corporate Bond ETF (USIG) attracted a small amount of flow.
Hard currency emerging market debt is going to suffer this year as the Federal Reserve hikes interest rates. However, local currency debt will remain supported as the majority of EMs have already hiked rates last year. Therefore, EM’s central banks will not need to tighten their economies, supporting their country’s recovery. That’s why since the beginning of the year, local currency debt remained stable, while hard currency EM debt fell 4% in value.
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