Friday, September 9, 2016
Treasury Yield Spike Not to Be Ignored
In the last two trading sessions, Treasury yields have spiked higher. Below I will discuss technical conditions, changes in the funding markets, positioning realities, economic conditions and monetary policy happenings that point to how this situation developed and what may be forthcoming.
The bearish ‘Three Rivers’ candlestick pattern in Treasuries (Eurodollar Futures) noted yesterday, has found confirmation in the price action today. I am particularly impressed with the price action in the Bonds and Ultra Bonds that have traded well below the consolidation band which stretches to late-June. This yield break-out is all the more impressive as it follows shortly after (July 7-8) new historic low yield marks.
There seemed to have been some attempt at recovery when post-employment report selling held at the aforementioned trading band lows. The recovering price action on Tuesday, which by itself looked impressive, was followed by rather indecisive session on Wednesday. The technical pattern finished with a strong decline on Thursday. In many contracts, Thursday’s sell-off was as large (open to close) as any seen since December. Today’s price weakness, pushing yields to the highest levels in since June helps to confirm the bearish technical conditions.
To expand the story line, we might note that the early-July historic yield low levels were achieved following the UK ‘leave’ vote which caught a good number of positions offside. The fall-out from that positioning and a short-lived mistaken read of the situation as a ‘black swan’ helped to drive yields lower than economic conditions might have implied.
While economic data since has been somewhat mixed, the employment situation appears to be rather supportive of future consumer spending. Residential real estate is also rolling along well enough and commercial real estate has offered some signs of excess. Manufacturing continues to bump along, but got a somewhat surprising note of better prospects from the latest FOMC Beige Book. Because employment has remained on a growth path well beyond that necessary to eliminate any remaining gap from full employment in relatively short order and because good argument can be made for progress made in attainment of the Fed’s inflation target, there is reason to expect the Fed to restart accommodation removal.
Concerns for lack of liquidity driving price action may not be entirely off base. Central banks having taken up a larger portion of available sovereign securities have created some liquidity constraints and funding market changes. In addition to these important changes, money market reform has brought pressure on prime funds which have pushed up funding costs in the unsecured Libor market. These changes were widely, though not universally, misunderstood early on as indications that the market was pricing for strong and sooner Fed rate hikes. There are still some concerns for additional spikes in funding costs as the October 14 approaches.
Expectation for the Fed’s uptake of accommodation removal once again may not be the primary reason for this Treasury sell-off. We know too well that many pension and insurance funds as well as money managers more generally, both here and more particularly in negative-yielding foreign nationals, have been stretching themselves by adding to duration in a hunt for yield.
A more recent absence of expected additions to QE and QQE from the ECB and BOJ may have removed some of the buying interest in global long rates. Expectations were strong for both CB’s to provide additional buying programs and traders likely positioned long in front of these expected outcomes. Doubtless, there are accounts that are still found off-side with the jump in Treasury yields and there could be some additional portfolio adjustments forthcoming.
Any additional economic repair will likely drive yields still higher. Stronger economic data will not be as friendly to the front end of the curve relative to the long end as has been the case over the last week or so. Instead, the front end may do some catching up as economic agents charge the Fed for a greater likelihood of trimming excess accommodation.
To summarize, the technical conditions are bearish and today’s price action helps to confirm this situation. Positioning by a very large investment community may be somewhat off-side from the recent jump in yields as they were instead looking for another leg lower in yield. Economic conditions, while not particularly robust are near expected potential and the economy has weathered some remarkably strong headwinds. Finally, Central Banks thought to have been on different paths with BOJ and ECB on easing trajectories while the Fed was geared toward rate hikes, may be more synced than imagined with all CB’s becoming less supportive.
The situation is dynamic, but there are clear signs that the investment community is changing its sentiment and because this has happened so close to a historic new yield low, we are charged with monitoring the situation rather closely. For now, the technical condition is bearish and expected to follow through. It will require a lot of energy to reverse the Treasury price declines of the last days. Not enough energy for a bullish bond recovery appears available over the next sessions at a minimum.