Yields Crack 1.3% as Bond Surge Signal Reflation Trade End

The rally in U.S. Treasuries forged on, sending 10- and 30-year yields to the lowest levels since February, as expectations for an inflationary economic recovery continued to fade.

After grappling with reflation premonitions for months, bond bulls are finally regaining the upper hand. The rate on 10-year Treasuries fell below 1.30% on Wednesday and the 30-year breached 1.92% as the delta strain of Covid-19 hobbled hopes for an imminent end to the crisis and a normalization of central-bank policy. In Europe and the U.K., 30-year yields led a pullback across the curve, while China’s bond futures posted their best rally this year.

HSBC Holdings Plc’s long-term bond bull Steven Major on Wednesday reiterated his forecast that 10-year Treasury yields will slide to 1% by the end of this year and still be there a year later.

Yields Crack 1.3% as Bond Surge Signal Reflation Trade End

The bond market repricing is reshaping expectations for monetary policy. The anticipated start dates for tapering of asset-purchase programs have been pushed back, with some in China even calling for interest-rate cuts.

“The market is increasingly sensing that yields may have already peaked this year,” HSBC’s Major wrote in a client note. “Reflation has largely been priced in and the bond market is looking ahead to what comes next.”

Yields Crack 1.3% as Bond Surge Signal Reflation Trade End

The 10-year benchmark rate touched 1.2946%, the lowest since Feb. 19, as it fell five basis points, adding to a nearly eight-basis-point drop yesterday. The 30-year breached its June 21 low and its 200-day moving average, which it last closed below in October. The yield gap between two- and 10-year notes fell below its 200-day moving average for the first time since March 2020 as it narrowed to less than 108 basis points, the smallest since February.

U.S. Federal Reserve officials have long insisted that this year’s inflation acceleration was a function of bottlenecks created by economic reopenings, and unlikely to be sustained. Still, the strength of the recovery prompted them to begin discussing asset-purchase tapering -- a precursor to rate increases -- at their June meeting, which also produced forecasts for an earlier start to rate increases.

Following the release of the minutes of that meeting Wednesday afternoon in Washington, the 10- and 30-year yields held generally steady at about 1.31% and 1.93% respectively. Meanwhile the gap between 2- and 10-year yields was about 109 basis points.

“In coming meetings, participants agreed to continue assessing the economy’s progress toward the Committee’s goals and to begin to discuss their plans for adjusting the path and composition of asset purchases,” details from the meeting said.

“Various participants mentioned that they expected the conditions for beginning to reduce the pace of asset purchases to be met somewhat earlier than they had anticipated at previous meetings in light of incoming data,” the minutes said.

Aberdeen Standard Investments now says yields could drop below 1.2%, while AllianceBernstein LP sees rates potentially sinking as low as 1.12% -- a far cry from predictions, just a few months ago, that yields could break above 2%.

“Investors have quickly transitioned from worrying about inflation to worrying about growth,” Neil Dutta, head of U.S. economic research at Renaissance Macro Research said in a note. “There is also growing fear around the Delta COVID variant and the impact globally.”

Interest-rate strategists said investor positioning for higher rates appeared to act as an accelerant by drawing in buyers aiming to stop losses. Tuesday’s gains had markers of being “exaggerated by short-covering,” JPMorgan strategists said in a note. Some of the heaviest volumes of the day in Treasury futures coincided with contract prices exceeding Tuesday’s highs.

Acting Sooner?

“Growth concerns around the delta variant are the key driver,” said John Taylor, a money manager at AllianceBernstein. Some investors are interpreting the Fed’s dot-plot shift as meaning it “will act sooner and therefore not raise rates as much as would be needed if they had allowed inflation to run hot for a lot longer,” he said.

Further support comes from the less-liquid summer months, when investors tend to buffer their portfolios with haven assets to protect against unexpected market jolts. On top of that, the supply-demand dynamic in bonds is unusually favorable -- the only securities on the Treasury department’s auction schedule this week are bills.

Still, Richard Hodges, a money manager at Nomura Asset Management sees the recent rally as an opportune time to initiate fresh short positions given that many other assets like oil are still flashing inflationary warning signs. While Major is still bullish, he said investors should turn tactically “neutral.”

“It’s madness to think we are in a bond bull market,” Nomura’s Hodges said. “Everything else is higher -- equities, inflation, oil prices, food, wages. And yields are going lower as we are sold the inflation roll-over transition.”

Traders, for now, have a close eye on the economic data and the steady drip of clues on the outlook from central banks. Tuesday’s Treasury rally was initially spurred by the ISM Services Index for June falling more than expected from May’s record high. After the minutes of the Fed’s June meeting comes the highlight of its year: the Jackson Hole symposium in August.

“The next few weeks, ahead of the Jackson Hole, could see a continuation of the squeeze as it’s clear from yesterday’s price action that a short base exists in the market,” said Aberdeen’s O’Donnell, who has added bond duration across portfolios. “The only thing that’s really ‘reflating’ is asset prices.”

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