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Bond Traders' Wild Ride in 2018 Is About to Kick Into Overdrive

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(Bloomberg) -- You’ve traded on inflation data and the prospect of rising sovereign-debt supply. You’ve wagered on Federal Reserve meetings and what the next chairman might do. And you’ve bet on jobs and wage growth that exceed or miss targets.

Now try doing it all in one week. 

With yields threatening to leap higher, bond traders will grapple this week with market-moving stimuli coming at breakneck speed. The selloff in Treasuries less than a month into 2018 has already sparked calls of a bear market, including from Ray Dalio, founder of hedge fund Bridgewater Associates. 

U.S. domestic events are about to take center stage, after decisions by the Bank of Japan and European Central Bank left 10-year yields close to the highest since 2014. Traders will have a few things on their minds: Janet Yellen’s final meeting as Fed chair, the Treasury’s plan to cover widening deficits, and, to cap it all off, an update on the U.S. job market.

“It seems almost impossible how much is jammed into one week,” said Michael Lorizio, a senior trader at Manulife Asset Management, which oversees $383 billion. “The more responsible shorter-term trading rationale is rather than making a major shift in your investments, being willing to miss the first few basis points to have your longer-term thesis proven or disproven by the new data and information.”

Fed Leanings

This week could wind up bolstering the prevailing view -- that yields are finally heading higher. While the Fed is seen standing pat, some Wall Street banks are bracing for a statement on Jan. 31 that comes off as “more hawkish” than last month’s, in part because of climbing inflation expectations.

The 10-year breakeven rate is the highest since 2014, signaling demand for protection against accelerating inflation. Fed funds futures are pricing in more than 2.5 rate hikes by the central bank this year, close to policy makers’ forecast for three. At the end of last week, options activity indicated growing interest in hedging against an extended selloff.

And then there’s supply. The Treasury is expected to unveil bigger note sales this week for the first time since 2009. More issuance just as the Fed is trimming its balance sheet and has a green light from markets to keep raising rates? Sounds like a tough environment for bond investors.

See here for more on the new reality of bigger debt sales.

To be fair, not everyone’s buying into the gloom. Dimitri Delis, senior econometric strategist at Piper Jaffray in Chicago, points to the deteriorating U.S. savings rate. As a share of disposable income, it fell to 2.6 percent last quarter, the third-lowest on record. That matters because consumers make up about 70 percent of the economy.

“I don’t know what’s going to keep the consumer on the same pace as the last two years,” he said. “I can probably string together events that can get us to 3 percent on the 10-year, but once it gets there, are the fundamentals there to support that level? I don’t think so.”

Then again, two months ago traders weren’t so sure that 10-year yields could break above 2.4 percent, and they’ve stayed above that level for five weeks. The trend for months has been for yields to climb and consolidate, before breaking even higher.

Last week, bond traders appeared to catch their breath. They’ll need it for the sprint ahead.

What to Watch

  • President Donald Trump’s State of the Union address on Jan. 30 at 9 p.m. ET
  • The Treasury announces quarterly refunding plans Jan. 31
  • Jan. 31 is also when the FOMC releases its latest policy decision, in Yellen’s final meeting as chair before handing off to Jerome Powell
    • San Francisco Fed’s John Williams, who emerged this month as a candidate for Fed vice chair, is set to speak on Feb. 2
  • A fresh read on the U.S. labor market and an update on the Fed’s preferred inflation gauge highlight economic indicators:
    • Jan. 29: Personal income and spending; PCE deflator and core PCE; Dallas Fed manufacturing activity
    • Jan. 30: S&P CoreLogic Case-Shiller home price indexes; Conference Board consumer confidence
    • Jan. 31: MBA mortgage applications; ADP employment change; employment cost index; MNI Chicago business barometer; pending home sales
    • Feb. 1: Challenger job cuts; nonfarm productivity; unit labor costs; initial jobless claims; continuing claims; Bloomberg consumer comfort; Markit U.S. manufacturing PMI; construction spending MoM; ISM manufacturing
    • Feb. 2: Change in nonfarm payrolls, unemployment rate and average hourly earnings; factory, durable goods and capital goods orders; University of Michigan survey data
  • Treasury bill auctions on Jan. 29 and Jan. 30

©2018 Bloomberg L.P.

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