Sit Out the Treasury Rally at Your Own Risk
Buildings stand illuminated at dusk in Osaka, Japan. (Photographer: Buddhika Weerasinghe/Bloomberg)

Sit Out the Treasury Rally at Your Own Risk

(Bloomberg) -- The longest weekly rally in Treasuries since 2012 may find another gear as bond traders turn their focus to Osaka, where world leaders descend next week for a pivotal Group-of-20 meeting.

Yields on 10-year Treasuries broke below 2% for the first time since 2016 this week after the Federal Reserve signaled it’s ready to lower borrowing costs, prompting a flurry of bets that a rate cut will happen in July. Ahead of the G-20 meeting, strategists at NatWest Markets, Bank of America Corp. and elsewhere see little standing in the way of even lower yields.

Sit Out the Treasury Rally at Your Own Risk

The U.S.-China trade dispute remains hot. On Friday, the U.S. Commerce Department barred five more Chinese entities from buying American-made products. Combined with tepid inflation and accumulating downside risks to U.S. growth, that means this is a dangerous time to bet against Treasuries, according to John Briggs, head of Americas strategy at NatWest.

“I would fade fixed income at your own risk right now,” he said. “I think the odds are low that China and the U.S. come to an actual agreement, or a ‘we made a lot of progress and expect a deal very soon.’”

Benchmark 10-year Treasury notes completed their seventh straight weekly rally on Friday. The yield has shrunk to 2.05% from 2.53% on May 3. Two-year notes are at 1.77%. NatWest expects Fed rate cuts in July and September to help push those yields down to 1.85% and 1.5%, respectively, by year-end.

Both Briggs and Bank of America’s Mark Cabana acknowledge that a better-than-expected outcome at next week’s summit -- namely, a delay of further U.S. tariffs -- could drive 10-year yields roughly 10 basis points higher in the short-term. However, lower yields are “the path of least resistance” in Cabana’s eyes.

“The real question is, what gets the Fed to not cut in July? I think you need more than positive vibes out of the G-20,” said Cabana, head of U.S. interest-rate strategy. “The Fed has shifted into downside risk-management mode.”

Bank of America is penciling in 75 basis points worth of cuts in the upcoming easing cycle, with the Fed’s first move in September -- though the “risks are skewed” toward an earlier cut in July, Cabana said.

Not So Fast

Not everyone is convinced. The post-Fed rally in U.S. bonds as well as bets on a more-than-25-basis-points July cut don’t make sense given the current state of the economy, according to Vanguard Group Inc. strategist Anne Mathias.

“It’s almost like the market is forcing the Fed to act, and that’s just a very weird environment,” she said during a panel at the Fixed Income Leaders Summit in Philadelphia this week. “I don’t think the Fed is going to respond to being forced.”

Auction Watch

While Cabana thinks G-20 developments will be the most important market driver “by far” next week, he’s also keeping an eye on auctions. The U.S. Treasury is scheduled to sell a combined $131 billion worth of two-, five- and seven-year securities in the days ahead.

The sales should proceed smoothly, Cabana said, given recent strong demand for U.S. debt, but he’ll be watching to see if the auction yield is higher than the prevailing market rate for the securities at the times bids close -- known as a tail.

“If they consistently tail, especially the two-year auction, then it might be a sign of investor fatigue,” Cabana said.

What to Watch

  • There’s a full slate of economic data, an appearance by the Fed chairman and note auctions to get through before the June 28-29 G-20 meeting.
  • Here’s the economic calendar:
    • June 24: Chicago Fed national activity index; Dallas Fed manufacturing index
    • June 25: FHFA house price index; S&P CoreLogic home price data; Richmond Fed manufacturing index; revisions to retail sales; new home sales; Conference Board’s consumer confidence
    • June 26: MBA mortgage applications; durable goods/capital goods; trade balance; retail/wholesale inventories
    • June 27: 1Q GDP; jobless claims; Bloomberg consumer comfort; pending home sales; Kansas City Fed manufacturing
    • June 28: Personal income/spending; PCE deflator; MNI Chicago PMI; University of Michigan sentiment
  • Fedspeak revs up:
    • June 23: Philadelphia Fed’s Patrick Harker in Aspen
    • June 25: New York Fed’s John Williams at finance forum; Atlanta Fed’s Raphael Bostic on housing; Chairman Jerome Powell speaks at Council on Foreign Relations on the economic outlook and monetary policy; Richmond Fed’s Thomas Barkin; St. Louis Fed’s James Bullard
    • June 26: San Francisco Fed’s Mary Daly in New York
    • June 28: Daly in Aspen
  • The auction calendar:
    • June 24: $36 billion 3-month bills; $36 billion 6-month bills
    • June 25: $40 billion 2-year notes
    • June 26: $18 billion 2-year floating-rate notes; $41 billion 5-year notes
    • June 27: 4-, 8-week bills; $32 billion 7-year notes

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