while we slept; "The Talking 10-Year Treasury" (DataTrek); bond bull TLINE (re)tested;
Good morning … aDURABLE goods were NOT so adorable and disappointed (ZH) and the reverse concession (ie BID) for 5yr USTs into 1pm liquidity event (aka auction) continued (and was good enough despite tail apparently as ZH NOTES a Solid 5Y Auction Sees First Drop in Yield Since December). This as the ‘rates market STARTS pricing in a Fed-FOLD’ (ZH)
This in mind and ahead of this afternoons liquidity event — a bit further out the curve and a somewhat better test of DEMAND, here’s a daily look at 7yy (which has H&S pattern forming and / OR look overbought — slow stochastics, bottom panel), to my unprofessional eyes … note I’ve ALSO etched in 55dMA just for goofs
#got7s?
… here is a snapshot OF USTs as of 721a:
… HERE is what another shop says be behind the price action (in their morning commentary titled, Tokyo Returns?),
… OVERNIGHT FLOWS
Treasury yields edged lower overnight with 10s reaching 2.702% -- a fresh low since April 14. Overnight volumes were near the norms with cash trading at 94% of the 10-day moving-average. 10s were the most active issue, taking a 33% marketshare while 5s were a distant second at 24%. 2s and 3s combined to take 23% at 16% and 7%, respectively. 7s managed 11%, 20s 3%, and 30s 4%. We’ve seen buying in 5s as well as selling in the 10-year sector and further out the curve.
In today’s commentary you’ll also note,
…Our underlying bond bullishness further out the curve was also encouraged by new information regarding the flows from Japanese investors. Specifically, Japan’s Ministry of Finance published the weekly figures which showed the nation’s investors bought a net of $4.9 bn in overseas notes and bonds during the week ended May 20 versus purchases in the prior week of $2.9 bn. The prior two weeks combined $7.8 bn in net buying that ended a selling streak which lasted fifteen weeks and totaled net outflows of $73.9 bn. Within this period of heavy selling, there were two weeks that were effectively flat; although the broader trend of the last several months remains obvious. In addition, the early signs of toe-dipping in Tokyo nonetheless left the six-week moving-average at -$2.7 bn of selling versus -$3.5 bn during the prior week. This is clearly a region of interest given that historically, Japanese investors have been significant participants in US Treasuries and the market has been awaiting any indication that this core set of buyers is back.
Lets wait and see whatever this afternoon’s 7yr auction brings … and for some MORE of the news you can use » IGMs Press Picks for today (26 May) to help weed thru the noise (some of which can be found over here at Finviz).
And we’ve reached that part of the programming where I look to what Global Wall Street is saying and the narratives they are selling, sharing those which were once much more relevant to ME — such as these,
AllStarCharts (from May 19th),
Bonds Reach a Critical Inflection Point
… While the underlying trend is lower for bonds, these defensive assets are at a logical level to build a bottom… or at least put in a tradable low.
At the same time, if bonds do not experience some mean-reversion at this natural support level, that will be valuable information as well.
When price ignores a logical level of interest or fails to bounce off support, it simply speaks to the strength of the ongoing trend. In this case, that trend is undeniably lower.
While bonds aren’t ignoring this level, they haven’t really moved higher off it either. We’ll know more soon.
Regardless of how TLT reacts here, it’s currently offering a clean and well-tested level to define our risk against. If those 2018 lows are violated near 112, we want to keep riding this downtrend toward the 2014 lows around 101.
For now, our tactical outlook is neutral as a counter-trend move makes sense here.
How US Treasuries respond to their former 2018 lows in the coming weeks and months will provide us with critical information…
For MORE on TLT, see Kimble noted HERE
CitiFXs CoTD (yesterday, before the 5yr auction):
US5YR: Completed a head & shoulders top formation yesterday with a decisive close below the neckline at 2.82%. This formation suggests a target of 2.42% with intermediate support at 2.67% (55-day-MA).
US5YR completes head & shoulders top formation…
Other technical developments worth noting
US10YR: Completed a head & shoulders top formation last week with a close below the neckline at 2.89%. This formation suggests a target of 2.36% with intermediate support at 2.66% (55-day-MA)…
DataTrek offered this overnight:
The Talking 10-Year Treasury
We will devote today’s Data section to one question: “What are US 10-year Treasury bond yields really telling us and what do they mean for stock prices?”
The chart below shows 10-year yields back to July 2018.
Four points about this data:
As noted, the pre-Pandemic Crisis highs were on November 8th, 2018 at 3.24 percent. That was the highest level on the 10-year since 2011.
Recall that back in October 2018 Fed Chair Powell was actively promoting the idea that the neutral rate of interest was “a long way” from the then-current Fed Funds rate of 2.00 – 2.25 percent. That’s why 10-year yields went north of 3 percent. They were simply taking the Fed’s guidance at face value.
The Fed’s view on the neutral rate also caused a backlash in equity markets, with the S&P starting to break down in October and bottoming on Christmas Eve 2018, down 19.7 pct from its September 21st highs.
After a long period of low yields during and immediately after the Pandemic Crisis, 10-year Treasuries broke above 3 percent on May 5th, 2022 and hit a peak of 3.12 pct the next day. This time around, equity markets were ahead of the curve. They were already selling off before we hit the 3 percent yield threshold, and the May 20 S&P lows were 18.7 percent below the January 3rd highs.
Comment: the effect of a 3 percent 10-year Treasury yield on US large cap stock prices is one thing that has not changed since before the pandemic. We’ve been here twice in less than 5 years, and each time US large cap stocks have quickly dropped almost 20 percent. The bright spot is that once yields back away from 3 percent, equity valuations stabilize.
Moving on, let’s look at how 2022’s 3 percent Treasury yield is different from 2018’s version. The answer is expected future inflation. As the chart below shows, future CPI inflation implied by 10-year Treasury Inflation Protected Securities (TIPS) was 2.1 percent in November 2018. At its highest levels on April 21st 2022, it was 3.0 percent. Since then, expected inflation has come down to 2.6 percent. That is still well above the Fed’s 2 percent target, however.
Comment: the 3 percent 10-year yield in November 2018 is very different from the one in May 2022, in that the former was set against a backdrop of modest inflation expectations but the latter is not.
Now, let’s get to the elephant in the room: why are 10-year Treasury yields declining just now? At one level the answer is simple. Inflation expectations are coming down, as shown in the second chart. But why are those dropping? Only two answers come to mind:
The first is that the Treasury market is starting to discount an inflation-killing recession. With the stock market on shaky ground, that’s a totally fair assumption to at least entertain.
The second is that Treasuries believe inflation will come down on its own without the need for a corporate profit-reducing recession. Some combination of higher rates, modestly reduced consumer spending, and lower wage inflation might just do the trick.
Comment: both a slowdown and then eventual recession are possible, so bond markets are likely saying that it makes no difference to them which ends up being right. Either way, inflation is coming down. It’s also worth noting that Treasury yields are declining right into the June start of the Fed’s balance sheet reduction. This implies that this market believes there will be plenty of buyers for that paper at current yields.
Before we wrap up, a quick comment on how Fed Funds Futures responded to today’s FOMC May meeting minutes in terms of expected year-end policy rates: they barely budged. Futures now give 60 percent odds of rates ending the year at 2.50 – 2.75 percent and 33 percent odds of 2.75 – 3.00 percent. Just before the minutes were released, these odds were exactly the same.
Takeaway: lower 10-year yields give US stocks some breathing room right here, but the setup for equities remains very cloudy:
First, this is not 2018. Inflation expectations remain too high, even now, for the Fed to alter its rate hiking plans any time soon. The institution’s credibility is on the line, and that’s not changing any time soon.
Second, we can’t be sure that 10-year yields are signaling an economic soft landing rather than a recession. Treasuries don’t care about corporate profits, after all.
Lastly, it’s not like any driver of structural inflation has really turned the corner. The NY Fed’s measure of supply chain stress was up last month. Oil prices are still +$110/barrel. Initial unemployment claims are only creeping higher, a sign the US labor market remains hot. It simply feels too early to assume that inflation will move convincingly lower any time soon.
The bottom line is that US stocks should stabilize over the near term, but we’re not convinced this is the bottom. Lower rates absolutely help valuations, but they also call into question just how strong future earnings might be. That remains the crux of the problem for equity valuations, and whether the 10-year is above or below 3 percent sheds little light on this important issue.
DB on 10yy vs cross-asset pricing
UST10y is back in line with other asset classes. The following variables have been historically correlated with UST10y: copper/gold, Financials/S&P500, JPY, and oil (6m change). Using these four variables, we calibrate a cross-asset proxy to UST10y over the 5-year period 2010-2014. We then used this cross-asset proxy out-of-sample to assess the relative cheapness/richness of UST10y.
From September 2020 to February 2022, the cross-asset proxy was indicating that UST10y was too low by ~90bp on average. Following the March/April sell-off, UST10y overshot the cross-asset proxy by ~50bp. After the recent pull back, UST10y is now in line with the cross asset-proxy. Note that UST10y had overshot its cross-asset proxy for three months by ~75bp before the Fed U-turn in 2018. Our prior is that the drastically different inflation environment should ultimately lead UST10y to overshoot the cross-asset proxy by more than it did in 2018.
Finally, this from BBGs Cormac Mullen and what HE is interested in → BONDS,
… The most important chart in the bond market is back, only this time to be looked at in reverse. The four-decade long downtrend marking the historic bull market for bonds is being tested once more by 10-year Treasury yields, just now as a line of support. The global bond benchmark broke above the trendline last month in a sign that the bull market was over, so a sustained push below it will raise questions of whether that was only a false break. Bond yields worldwide have pulled back from recent highs as fears of a recession overtake concerns about rising inflation. Belief in a false break could encourage further buying, adding momentum to the pullback, while a bounce off support could trigger a fresh wave of selling. Giant investors from JPMorgan Asset Management to BlackRock Inc. have already been hinting that the worst of the selloff in bonds is over even as inflation surges and more rate hikes loom. Still, Treasuries have to first navigate the shrinking of the Federal Reserve's $8.5 trillion bond portfolio -- a process which begins next month.
… THAT is all for now. Off to the day job…