Treasuries Rally, Emboldening Bond Bulls Who See an Inflation Peak

(Bloomberg) -- Long-maturity Treasury yields collapsed Wednesday after beginning the day at the highest levels in years. Robust demand for an auction of 20-year bonds added fuel to a move that began after several strategists said the bond selloff had gone too far.

The 30-year yield -- which exceeded 3% on Tuesday for the first time since 2019 -- declined as much as 13 basis points to 2.86%. The 10-year yield fell as much as 12 basis points to 2.82% vs a session high near 2.98%. Long-dated U.K. and German yields also fell after reaching multiyear highs Tuesday. 

Shorter-maturity yields declined less as futures markets continued to price in an aggressive path for the Federal Reserve’s policy rate aimed at getting inflation under control. Swap contracts that reference Fed meeting dates on Wednesday priced in half-point rate increases at each of the next two meetings in May and June. The market-implied odds of that outcome had been hovering just below 100% for weeks.

“There’s been a dramatic repricing in the rates market,” said Peter Yi, director of short-duration fixed income at Northern Trust Asset Management. “There are a lot of dip-buyers waiting for 3%, and it’s hard to see the 10-year staying there.”

The rally intensified after the 20-year bond auction drew a yield of 3.095%, three basis points lower than where it was indicated moments before the bidding deadline at 1 p.m. New York time, a sign that demand exceeded dealers’ expectations. The auction also produced strong bidder-participation metrics including the biggest award to indirect bidders in the recent history of 20-year bond sales.

But the rebound was well under way before the auction, following bullish market calls by strategists at Bank of America and MUFG Securities, among others.

The 10-year U.S. rate “offers an attractive level to buy,” Bank of America strategists including Ralph Axel wrote in a note to clients on Wednesday. “Our forecasts point to inflation peaking this quarter and falling steadily into 2023.” They predict the 10-year yield will retreat to 2.25%. 

Bank of America’s forecasts suggest U.S. inflation peaked in March. Markets are “reasonably well-priced” for a Fed hiking cycle of about 225 basis points of hikes this year, including the initial quarter-point increase in March, the strategists wrote. 

The double whammy of rate hikes and measures to shrink the Fed’s holdings of Treasuries will “exacerbate the economic slowdown that lies ahead,” George Goncalves, head of U.S. macro strategy at MUFG, said in a note. “This will eventually result in the bond market rallying back 75 basis points or more in the second half, initially via a bull flattener from the peak in rates and result in Fed cuts in 2023.”

U.S. short-end bonds could also become a “magnet for cash” according to Mizuho International Plc strategists including Peter Chatwell, given how much is already priced in for the Fed hiking cycle. 

Meanwhile, in the euro-zone government bond market, Nomura Asset Management portfolio manager Dickie Hodges is laying trades on short-maturity German bonds that should profit if markets price in less policy tightening by the European Central Bank. 

The rebound in Treasuries from their lows of the day began amid reports that Japanese pension funds and life insurers were buying, and gathered pace after strong demand for a sale of 30-year German debt.

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