Raging Rates And Bond Markets On The Boil

Since late March, when an acute growth scare, a dovish Fed and convexity flows sent bond yields tumbling, analysts have been forced to consistently revise lower their year-end yield forecasts.

To be sure, forecasting DM bond yields nine months out is largely an exercise in futility. As Morgan Stanley’s Matthew Hornbach put it in February of 2018, “history has shown that consensus estimates for Treasury yields are usually wrong [and] everyone understands that accurate point forecasts rarely occur”.

But despite the futility inherent in the exercise, analysts make a go of it year in and year out. Amusingly, Barclays’ clients were pretty accurate in 2018 when forecasting yields a quarter ahead, but as the bank noted in their most recent macro survey, investors’ track record worsened materially in 2019 as central bank dovishness and growth concerns pushed yields ever lower.

(Barclays)

Rates vol. has moved higher at various intervals, starting in late March and flaring up periodically as the rapidly evolving policy outlook and ongoing signs of global economic malaise collide with unpredictable trade policy.

This week, 10-year yields dove an astounding 23bps, one of the largest moves since Brexit. BofA’s MOVE index jumped the most Thursday since May. It rose further on Friday.

(BBG)

The Fed usually pauses or cuts when inflation expectations are under pressure, but there are serious questions this time around as to whether one or two “insurance” cuts are going do it when it comes to resurrecting confidence.

“UST 10s are now close to our 3Q19 target of 1.85% (and 4Q19 target of 1.75%), raising the risk of overshoot to the downside”, Goldman says. (The bank slashed their year-end targets back on June 26.)

“On the whole, we continue to believe USTs will trade with a bullish bias as the trade war and risks from Europe outweigh the modest strength seen in US data”, the bank goes on to write, adding that not only is there more downside for breakevens due to “a reluctant Fed and risk of increased deterioration in growth/risk sentiment”, but it’s not totally out of the question that the 2016 lows will be revisited.

(Goldman)

At the front-end, Goldman notes that the reaction to the Fed suggests a policy mistake, an interpretation most market participants and observers jumped on Wednesday. “The market pared cut pricing over the next couple of years modestly while longer dated forwards (2022 and beyond) made new lows in yields against a backdrop of risk-asset and traded inflation weakness”, Goldman went on to say, in a Friday note.

(Goldman)

Of course, Donald Trump’s latest China escalation forced traders to rethink their interpretation of the Fed again, just 24 hours after reassessing it on the back of Powell’s press conference. After all, part of the rationale for the US president’s latest trade broadside likely revolves around trying to compel policymakers to cut rates further. “Following the trade war escalation on the heels of the softer ISM Thursday, the earlier post-Fed cheapening at the front-end completely reversed, while markets priced deeper cuts still further out”, Goldman remarks.

To be sure, the situation is “fluid”. To employ Powell’s vernacular (and to snag a joke from Bloomberg’s Weekly Fix newsletter), bond markets have been brought to a “boil”.

“It was difficult enough for rates traders to contemplate curve trades after the Fed, before trade policy was thrown into the mix”, Bloomberg’s Luke Kawa wrote Thursday evening. “Different curves have spent this week quickly contorting themselves into and out of positions that would earn the admiration of the most experienced yogis”, he quipped, before sighing that “the outlook for short rates — which had been coalescing — has been torn asunder”.