The underlying message is that the US economy isn’t just in fine fettle, it’s on fire.
That’s from SocGen’s Kit Juckes, out Thursday morning, and it underscores the notion that Wednesday’s ADP and ISM data betray a U.S. economy that is, as we put it, “a screeching tea kettle“.
“Fed Chairman Powell acknowledges that the funds rate is likely to get above ‘neutral’ (i.e., above 3%) at some point, albeit slowly”, Juckes goes on to write, before adding that while “the Fed is following the data, a re-steepening of the yield curve suggests that some think they are getting left behind a bit.”
Wednesday’s rather remarkable bond selloff (see linked post above) was sparked by the ADP beat and a hot ISM services print, which put a lit match to kindling that was extra dry thanks to the temporary abatement of budget woes in Italy.
What happened after that is anyone’s guess, but given futures volume, folks were likely stopped out. “To be sure, strong momentum in economic data is the trigger but we suspect real money investors are throwing the towel on longs after the recent breakout”, SocGen wrote, in a separate note from the one cited above.
That said, Bloomberg notes this morning that CME open interest changes “showed that Wednesday’s selloff was largely driven by an increase in short positions, mostly in 10-year and bond futures”.
Remember, specs were already record short. We’ll get the latest CFTC data on Friday, but this is where things stood through Tuesday, September 25:
Volume was heavy overnight as well and a break above 3.20% catalyzed a deluge of selling. As Bloomberg goes on to detail, more than 20k 10-year contracts traded on the break of 3.20%.
Bunds and gilts sold off as well and it seems like just a matter of time before the market tests the BoJ’s mettle by pushing 10Y JGB yields up to 0.20%.
Where this stops is now anyone’s guess. Oil prices don’t look like they’re inclined to pullback, the U.S. data doesn’t look like it’s inclined to tip a slowdown any time soon, and then there’s Fed balance sheet rundown.
On that latter point, don’t forget that the Fed is pulling its support for the U.S. debt market a time when Treasury’s borrowing needs have gone up dramatically thanks to Trump’s late-cycle stimulus push. The supply/demand dynamic has changed markedly and given that the U.S. fiscal outlook is deteriorating, this is a delicate time to put more of the onus for absorbing supply on private, price-sensitive investors.
Meanwhile, overseas demand could wane due to higher hedging costs. Hedged yields turned negative for European and Japanese buyers late last week.
Also, I would note that anyone pointing to the stubbornness of the term premium and lagging breakevens should perhaps be counting their blessings. If the term premium starts to get rebuilt and inflation expectations start to become unanchored against the backdrop outlined above, well then things could get really messy for bonds.