Treasury Rally Risks Hitting a $125 Billion Wall

(Bloomberg) — Bond traders welcomed their first clear sign of a cooling U.S. labor market, but it's only part of what's needed to spark the truly transformative rally they've been hoping for all year.

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U.S. Treasury bonds rose on Friday after a government report last month showed surprising weakness in job and wage gains, adding to other recent evidence of slowing growth. The news capped a week-end rally that began Wednesday after Fed Chairman Jerome Powell pushed back on the need to raise rates and signaled cuts would come as soon as data warranted.

Investors are now cautiously increasing their bets for easing this year, and yields on Fed-sensitive two-year bonds are leading the market gains. And yet, despite all signs of slowing in some parts of the US economy, inflation remains stubborn – a reality that potentially limits what the central bank can do and means bond yields are likely to remain stuck at their recent levels.

In addition, next week's auctions of a total of $67 billion in 10- and 30-year Treasury bonds will test demand for longer-term debt, which has weakened among some investors. The government will also sell $58 billion worth of three-year bonds as part of its so-called quarterly redemption auctions.

The jobs report and Powell's comments were “a relief for the market, but by no means are we hitting the table and thinking we're going 50 to 100 basis points lower,” said Mark Lindbloom, portfolio manager at Western Asset Management. oversees approximately $385 billion. He believes that shorter-term U.S. securities, such as two- and five-year notes, are outpacing longer-term debt.

Powell said the policy is restrictive enough to eventually curb inflation and also reminded investors that the Fed would respond to signs of a weakening in job creation and wages. This dovish stance was underlined in the wake of Friday's employment data, when at one point US two-year yields fell to 4.7%, some 30 basis points lower than their high for the year of 5.04% on Tuesday. The benchmark stood at 4.81% on Friday afternoon.

Curve calculations

In the month leading up to last week, traders had clawed back their bets on multiple rate cuts this year amid data pointing to brutal growth and persistent inflation. Now market prices reflect expectations for almost two full cuts instead of just one as earlier last week.

While some rate cuts will keep two-year yields below last week's peak, the prospects for 10- and 30-year bonds are less attractive to investors if inflation remains above the Fed's target and Washington's thrift results in a new increase in long-term interest rates. auction sizes.

George Catrambone, head of fixed income at DWS Americas, prefers to own the two-year rate “as the likelihood of rate hikes remains low,” and remains “skeptical about the outer reaches of the curve,” which is he has been for “quite some time”.

After flirting with a new peak of 4.75% in 2024 last week, the 10-year stock traded at 4.5% on Friday. Any discount before the 10-year sell-off would see the issue yield a flat 4.5% coupon, matching the coupon briefly provided in November, the highest since 2007. While that looks good historically, Many investors are wary of fully embracing longer-term bonds. debts at the moment.

Read more: Bill Gross says the 'Total Return' strategy he pioneered is 'dead'

“The back end is more vulnerable to higher repricings” than the “capped” front-end rates, said Jennifer Karpinski, managing director at Jennison Associates, which oversees $50 billion in fixed-income assets.

Jennison favors a “steep trading strategy” in their portfolios, overweighting two-, three- and five-year U.S. Treasuries while underweight 10-year Treasuries. “It's hard to make a call when the long end becomes attractive.”

A steeper curve lies ahead as the Fed begins to cut spending and market prices ease further on softer data. That would result in US two-year yields falling faster than longer-term benchmarks. For potential buyers of the long end, the real payoff is that inflation will moderate, allowing the long end to join a front-end rally.

What Bloomberg Intelligence Says…

“The payroll report for April indicates that wage growth may be slowing. The Federal Reserve remains data-dependent, so the Treasury market could remain volatile within limits as data could be mixed in the near term.”

– Ira F. Jersey and Will Hoffman, BI strategists

Click here to read the full report

The data remains mixed. Countering Friday's jobs data, separate reports last week revealed persistent price pressures in the manufacturing and services sectors.

“Three months from now, we could see a very different picture of inflation,” said Mark Spindel, chief investment officer at Potomac River Capital, based in Bethesda, Maryland, which has added Treasuries at the other end of the curve. “I am again more constructive about the prospects for interest rates, that they can fall.”

Another path toward a steeper curve comes as the back end becomes more sensitive to high inflation, prompting investors to demand more compensation for owning longer-term government bonds. This so-called term premium, based on the New York Fed model, remains slightly negative and some investors believe that a true normalization from the recent ultra-low interest rate era equates to a positive outcome.

“You still don't see the term premiums coming back in the long term, and at some point we think they will come back,” Karpinski said. “In terms of reimbursement, they are not increasing auction sizes for now, but if they do increase over time, this is another factor that could increase revenues in the long term.”

What to watch

  • Economic data:

    • May 6: Opinion survey of senior loan officers on bank loans

    • May 7: Consumer credit

    • May 8: MBA Mortgage Applications; wholesale sales and supplies

    • May 9: Weekly unemployment claims

    • May 10: US sentiment and inflation expectations; monthly budget overview

  • Fed Calendar:

    • May 6: Thomas Barkin, president of the Richmond Fed, John Williams, president of the New York Fed

    • May 7: Minneapolis Fed President Neel Kashkari

    • May 8: Vice President Philip Jefferson; Boston Fed President Susan Collins; Fed Governor Lisa Cook

    • May 10: Fed Governor Michelle Bowman; Dallas Fed President Lorie Logan; Chicago Fed President Austan Goolsbee; Fed Vice Chairman for Supervision Michael Barr

  • Auction calendar:

    • May 6: 13 and 26 week bills

    • May 7: 42 days of cash management accounts; three-year notes

    • May 8: 17-week bills; 10-year notes

    • May 9: 4 and 8 week bills; Bonds with a term of 30 years

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