Biggest Bond Rally in a Year Stalls With Short Wagers Washed Out

The most torrid Treasuries rally in a year is likely set for a breather as traders reassess their rush to abandon reflation bets with some potentially decisive events looming in the coming days.

The 10-year yield, a benchmark for global borrowing costs, tumbled almost 20 basis points over the past two weeks, to 1.36%, in part as the rise of dangerous Covid-19 variants fueled an unwinding of short positions. It’s been a stunning stretch for a market that was flirting with a 2% yield on 10-year notes just a few months ago, and is now gauging the prospects for a march back toward 1%.

Traders say there’s a strong case for a pause. For one thing, options are signaling a wash-out of short bets. Then there’s next week’s calendar: a combined $120 billion of Treasury note and bond auctions, forecasts for another big U.S. inflation figure, and testimony by Federal Reserve Chair Jerome Powell. What’s more, yields failed to tumble below a key level that may prove difficult to crack right away.

“We could still make a hard run to 1%, but with inflation data coming out next week and auctions -- including supply in the back end of the curve -- we think this is a good fade opportunity,” said David Brownlee, a portfolio manager at Maple Capital Management Inc. in Montpelier, Vermont. “The technical objectives have pretty much been met now.”

Biggest Bond Rally in a Year Stalls With Short Wagers Washed Out

The 10-year briefly sank below 1.25% on Thursday, down a bit more than 50 basis points from its 2021 peak in March. The yield also bounced off its 200-day moving average, a measure it’s held above since November.

The past week’s rally was a headscratcher for some, with many strategists pointing to a shakeout of positioning for higher yields as a catalyst, one that may be exhausted.

‘Much Cleaner’

“Short covering has likely exacerbated the move,” Barclays Plc strategists said in a report looking at commodity trading advisers, macro hedge funds and fixed-income mutual funds. Performance data for the funds “suggest that positioning is much cleaner now.”

The bank recommends “fading the decline in long-term forward rates,” which it says reflect an overly pessimistic economic outlook, but doing it via derivatives to limit downside risk.

Against this backdrop, momentum could favor a backup in yields as traders look to re-establish short positions or curve steepeners. The 10-year yield rose Friday for the first time this month as traders looked to auctions starting Monday, when the Treasury sells 3- and 10-year notes. An auction of long bonds follows Tuesday.

That’s the same day the government is forecast to report that consumer prices rose at a 4.9% annual pace in June, just below the roughly 13-year high from May. Persistently elevated readings could eventually lead investors to question the Fed’s take on price pressures as a temporary phenomenon resulting in part from the economy’s reawakening from the pandemic.

A key focus next week comes Wednesday and Thursday, when Powell testifies to Congress. The appearances offer him a chance to reinforce the Fed’s June message, which the market took as a sign that policy makers were ready to act to keep the economy from overheating. As such, his remarks could prove another chance for yields to rebound.

Lower Still

Of course, the outlook for next week doesn’t mean calls for lower yields are kaput.

Strategists at BMO Capital Markets are telling clients that the 1.21% to 1.22% range still stands as a target for the 10-year yield. That area represents a so-called trading gap from February that will serve as important price resistance.

And for those looking longer-term, the stalled rally doesn’t alter some bullish bond views, including for Hoisington Investment Management’s Lacy Hunt.

“The direction of yields is lower,” he said. “We are dealing with cyclical problems, structural problems and also a global economy that is in very poor shape -- as well as an over-indebtedness problem. The drop in yields we’ve had already is confirmation that the economic and inflation outlook have been deteriorating.”

What to Watch

  • The economic calendar
    • July 13: NFIB small business optimism; CPI; real average earnings; monthly budget statement
    • July 14: MBA mortgage applications; PPI; Fed Beige Book
    • July 15: Empire manufacturing; Philadelphia Fed business outlook; jobless claims; import/export prices; industrial production; Langer consumer comfort
    • July 16: Retail sales; business inventories; University of Michigan sentiment; Treasury International Capital flows
  • The Fed calendar:
    • July 12: Minneapolis Fed’s Neel Kashkari
    • July 13: Fed event on racism and the economy, featuring Kashkari, Atlanta Fed’s Raphael Bostic and Boston Fed’s Eric Rosengren
    • July 14: Powell before House panel; Kashkari; Beige Book
    • July 15: Powell before Senate panel; Chicago Fed’s Charles Evans
    • July 16: New York Fed’s John Williams
  • The auction calendar:
    • July 12: 13-, 26-week bills; 3-, 10-year notes
    • July 13: 52-week bills; 42-day cash-management bills; 30-year bonds
    • July 15: 4-, 8-week bills

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