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Auction uptick amid imminent death of bond bull market

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The $14.9 trillion Treasurys market is at an inflection point.

U.S. yields soared last week, busting through levels that seemed out of reach just months ago. The 10-year closed above 3% the last five days, a testament to how traders have grown accustomed to that psychological level. Even the resilient long bond gave in. The 30-year yield closed once (but not twice) above 3.22% — the threshold that DoubleLine’s Jeffrey Gundlach said is key for the market. Investors may need a moment to let it all sink in.

And yet the auction calendar waits for no one. The Treasury will sell a combined $99 billion of fixed-rate notes this week, in some of its largest offerings since 2010, with yields at the highest in years. That’s on top of more than $150 billion in likely bill issuance, plus $16 billion of floating-rate securities.

Add a slew of Federal Reserve speakers (capped by the chairman) who may reiterate plans for gradual rate hikes, and it could be a recipe for higher yields. Hedge funds and other speculators are banking on that: Their net short position in 10-year futures as of May 15 was close to a record.

Last week’s leap in yields has just about “put an end to the secular bull market,” Marty Mitchell, an independent strategist and former head government-bond trader at Stifel, said in a note Friday. “With the U.S. deficit expected to explode and as the U.S. debt load builds, it is only a matter of time.”

The benchmark 10-year yield ended the week at 3.06%, after reaching 3.126%, a level unseen since 2011. The 30-year yield, at about 3.2%, touched the highest since 2014.

The focus of this week’s auctions will be shorter maturities, which could re-energize a months-long trend toward a flatter yield curve. Traders will scrutinize the latest Fedspeak for signs of concern about the shape of the curve, with chatter emerging among market participants that officials might even slow rate hikes to keep the curve from inverting.

So far, there’s no sign the market anticipates that. In fact, rising oil prices and firming inflation expectations have traders bracing for a more aggressive Fed. They’ve priced in between two and three more rate hikes by year-end. And for 2019, they see almost two quarter-point increases, after barely pricing in one a month ago.

Of course, not everyone is ready to sound the death knell for the bond market. Strategists at Credit Agricole said that while near-term momentum points to higher yields, the impact on other assets will contain the losses.

“We are not at the start of a bear market,” they wrote in a report Friday. “Given the negative impact on emerging markets, U.S. high yield and equities, a further rates sell-off should be self-defeating.”

Indeed, last week saw a deepening selloff in emerging-market assets. The S&P 500 also declined.

And speculators could get squeezed out of Treasurys shorts. That’s what BMO Capital Markets strategists are counting on to drive yields lower.

These investments offered better returns than the broader fixed-income world in recent years, but the risk/reward equation leans heavier on risk.
September 28

For now, though, it’s hard to argue with the bears. In a stretch without top-tier data or big auctions, Treasuries slumped and the curve from two to 10 years steepened the most since February.

This week, Fed Chairman Jerome Powell gets the final say, at an event in Stockholm on Friday.

The timing means U.S. traders will have a few hours to potentially recalibrate their view on the bond market’s direction, before heading off for a long holiday weekend and the unofficial start to summer.

Bloomberg News