It could be the euro's time to shineThis may not be a popular theme, but that is usually the case at turning points. Like it or not, EUR/USD bears have failed to break the August low, and the rally on the USD index and yields looks exhausted. Every trend needs a retracement, and I suspect a small one, at a minimum, is due.
MS.
US02Y
Gold Rush Knocks Dow Jones Industrial Average Off Its FeetGold as a value asset continues to shine brightly, having reached a new all-time high near $2,600 on Monday, September 16, marking the 30th all-time high for gold prices this year, 2024.
It is also noteworthy that the Dow Jones Industrial Average (DJI) to gold (XAUUSD) ratio is gravitating to ever lower values, while the time-tested indicator of a U.S. recession, based on the US labor market behavior signaling that one is imminent.
Thanks to @chinmaysk1 and its full of worth open source script Recession And Bull Run Warning, that I truly believe is one of the best over many.
Yield Curve Reinverts on Easing Rate Cut ExpectationsFed sets the rates. Rates guide treasury yields. Fed remains data dependent. Incoming data creates nuanced shifts in yield spreads.
The September jobs report revealed 254,000 jobs added, significantly exceeding expectations of 147,000, with August figures also revised upward. This strong report, along with the JOLTS data from earlier in the week, indicates that the job market remains strong and not as weak as previously anticipated.
Despite the strong jobs data, the yield curve has inverted once again. While Mint Finance has previously highlighted that recession risks can lead to the yield curve inverting, that is not the only reason. This time around, the inversion is being driven by delay in rate cut expectations. CME’s Yield Futures enables investors to deftly express their views on the path of rates ahead.
JOB MARKET SHOWS MIXED SIGNS OF RECOVERY
The latest JOLTS figures showed U.S. job openings rising from 7.711 million to 8.090 million in August, with the previous month's numbers revised up by 38,000. Although job openings remain near a two-year low, the increase is a positive sign.
Rise in job openings was primarily due to increase in construction jobs (+138k), which are often seasonal, and government jobs (+103k). However, the overall report paints a mixed picture. Hiring fell by 99k from the previous month, and while total separations dropped by 317,000, the largest contributor was a 159,000 contraction in quits.
With fewer hires and a large drop in quits, the data suggests the job market is not particularly strong, as workers hesitate to leave their current positions with fewer being hired into new roles.
The Non-Farm Payrolls (NFP) showed 254,000 jobs added in September, with health care, social assistance, and leisure and hospitality sectors leading the gains. As a result of these additions, the unemployment rate eased to 4.1%. Hourly earnings grew by 4% YoY, with the previous month's figures revised upward to 3.9%.
RATE CUT EXPECTATIONS TEMPER
Further rate cuts are still expected, but the anticipated pace has slowed. Before the PCE inflation report on September 27, CME FedWatch indicated a cumulative 75 basis point reduction over the next two FOMC meetings in November and December.
Source: CME FedWatch
CME FedWatch tool also indicated a high probability of 100 basis-point cuts last month. However, after the encouraging PCE report, which showed inflation easing to 2.2%—its lowest level since 2021 and close to the Fed's target—the probability of a cumulative 50 basis-point cut has steadily risen.
Following the jobs report last week, the probability of cumulative 50 basis-points cuts surged to 80%.
The trend suggests that market participants are increasingly expecting a soft landing, with inflation easing and the job market remaining strong. A soft landing reduces the urgency for aggressive rate cuts, giving the Fed more flexibility to monitor the effects of previous rate hikes and lower rates more gradually.
Source: CME FedWatch
Crucially, Fed Chair Jerome Powell has suggested a similar outlook for rate trajectory. While speaking at the National Association for Business Economics, he suggested that if the economy continues on its current trajectory, he expects two more smaller rate cuts this year, or cumulative rate cuts of 50 basis points at the next two meetings. FOMC projections also signalled a similar rate outlook for 2024 as signalled by the dot plot below.
Source: FOMC
YIELD CURVE RE-INVERTS
Bond yields have increased sharply to their highest level since August on tempered rate cut expectations.
Crucially, the increase has been much sharper for the 2-year yields indicating near-term expectations of elevated rates for longer.
The result has been a re-inversion in the yield spread with 2-year & 10-year treasury yields now on par. Notably, the yield futures spread has declined more sharply than the treasury yield spread.
HYPOTHETICAL TRADE SETUP
Recent economic data points to rising likelihood of a soft landing. Expectations of rapid rate cuts have tempered accordingly. While rates are expected to continue declining, the pace is expected to slow with a cumulative 50 basis points (“bps”) of further cuts in 2024 likely.
As rates remain elevated for an extended period, the yield curve has begun to invert again. With current inflation easing, the inflation premium on long-term treasuries has diminished.
FOMC projections suggest a gradual path toward rate normalization, suggesting a potential near-term yield curve inversion before it eventually normalizes. Investors can express views on this outlook through CME yield futures.
Further, the yield futures spread is trading at a (~5bps) premium to the treasury yield spread, as the futures contracts approaches expiry on October 31, the futures spread will converge towards the treasury yield spread which further benefits the short position.
CME Yield Futures are quoted directly in yield with a 1 basis point (“bp”) change representing USD 10 in one lot of Yield Future contract. This simplifies spread calculations with a 1 bp change in spread representing profit & loss of USD 10. The individual margin requirements for 2Y and 10Y Yield futures are USD 330 and USD 320, respectively. However, with CME’s 50% margin offset for the spread, the required margin drops to USD 325 as of October 8, making this trade even more compelling.
A hypothetical trade setup comprising of long 2Y yield October futures and short 10Y yield October futures with reward to risk ratio of 1.5x is described below.
Entry: 13.5 bps
Target: -1.5 bps
Stop Loss: 23.5 bps
Profit at Target: USD 150 (15 bps x 10)
Loss at Stop: USD 100 (10 bps x 10)
Reward/Risk: 1.5x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme .
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Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Very close to Yield Curve Inversion, AGAINAfter #InterestRates were cut people were expecting a furious wave of buying, this has not come into fruition.
Recent events:
2Yr Yield rallied substantially.
10Yr #Yield bottomed when we called it, has not run as much as it's shorter term counterpart.
We're close to inversion again!
Colored areas = POTENTIAL Inverse Head & Shoulder = BOTTOM.
Worth noting, TVC:TNX has a higher right shoulder.
Further analysis:
We are seeing a Negative Divergence on $DJI.
Volume has been lessening as the days go by.
TVC:RUT Small Caps are LOWER and trading in a tightening range.
U.S. Dollar Index is near to fall. Soon..The US Dollar Index (DXY), which measures the value of the US Dollar (USD) against basket of other six major currencies, extends its losses for the 5th consecutive week in a row, hovering below 102 points during the U.S. regular hours on Monday, August 19.
Over the past week, Gold spot (XAUUSD) has topped $2500 per ounce psychological high also, minting new all the history peak, while Forex Eur/Usd (EURUSD) pair just has flashed a positive 2024 YTD return, jumping above 1.10 psychological degree.
The US Dollar continues to weaken following dovish comments from Federal Reserve (Fed) officials, which have increased a new portion of expectations for an interest rate cut by the central bank in September. Furthermore, last week’s US economic data revealed that both the Producer Price Index (PPI) and Consumer Price Index (CPI) suggest that inflation is easing.
Federal Reserve Bank of San Francisco President Mary Daly stressed on Sunday that the US central bank should adopt a gradual approach to lowering borrowing costs, according to the Financial Times. Daly countered economists' concerns that the US economy is facing a sharp slowdown that would warrant rapid interest rate cuts.
Additionally, Federal Reserve Bank of Chicago President Austan Goolsbee cautioned that central bank officials should be careful not to maintain a restrictive policy longer than necessary. Although it's uncertain whether the Fed will cut interest rates next month, failing to do so could negatively impact the labor market, according to CNBC.
Additionally, the decline in the US yields contributes to downward pressure for the Greenback. 2-year and 10-year yields on US Treasury bonds stand at 4.05% and 3.85%, respectively, at the time of writing.
This week, all eyes will be on Federal Reserve Chair Jerome Powell's upcoming speech.
In a bottom line, the major technical graph for the US Dollar Index (DXY) indicates on possible huge decline for the next upcoming 12 to 18 months.
The secondary RSI(14) graph indicates also, the bearish sentiment prevails.
What if bonds are kinda important?Lets draw few parallel lines. Looks like cross of green supports shows start of the party and crossing red resistances means music isn't playing anymore. Could be coincidence. Looks like green support is coming. If we pierce it could be bullish. Unfortunately this time is different because of inversion. We will see.
Hmm... Something Interesting & Sweet is Brewing in T-Bond MarketIEF is a longer maturity, longer duration play on the US Intermediate Treasury segment. The fund focuses on Treasury notes expiring 7-10 years from now, which have significantly higher yield and interest rate sensitivity than the notes that make up our broader 1-10 year benchmark.
IEF`s average YTM is significantly higher than US-T Aggregated benchmark's. Of course, the higher yield comes with significantly higher sensitivity to changes in rates, particularly those at the longer end of the yield curve (10-year key rate duration).
The fund changed its index from the Barclays US Treasury Bond 7-10 Year Term Index to the ICE US Treasury 7-10 Year Bond Index on March 31, 2016. This change created no significant change in exposure.
IEF's narrow focus and concentrated portfolio have been popular, so the fund is stable and easy to trade.
The main technical graph represents IEF' Total return (div-adjusted) format, and indicates on developing H&S structure, as US Federal Reserve tight monetary policy seems is near to ease.
Gold predicting that Big falling rates cycle has almost overThere are several factors that can drive gold prices up in long term. Some of the key factors include:
1. Global Economic Uncertainty: Gold is often seen as a safe-haven asset during times of economic uncertainty or market volatility. Investors tend to flock to gold as a store of value when traditional investments like stocks and bonds are perceived as risky.
2. Inflation: Gold is often used as a hedge against inflation. When inflation is high and inflation expectations are going even higher, the purchasing power of fiat currencies decreases, leading investors to turn to gold as a way to preserve their wealth.
3. Geopolitical Tensions: Political instability, conflicts, and geopolitical tensions can also drive up gold prices. In times of uncertainty or conflict, investors may seek the safety of gold as a reliable asset.
4. Central Bank Policies: The monetary policies of central banks, such as interest rate decisions and quantitative easing measures, can impact gold prices. While investors thoughts that lower interest rates and expansionary monetary policies tend to be supportive of higher gold prices are widespread, in reality - higher due to inflationary concerns interest rates are more supportive for gold prices.
5. Demand and Supply: Like any commodity, gold prices are influenced by supply and demand dynamics. Factors such as jewelry demand, industrial demand, and gold production levels can all impact the price of gold.
These are just a few of the factors that can drive gold prices up. It's important to note that gold prices can be influenced by a wide range of economic, geopolitical, and market factors.
The main Graph is an Annual chart for ratio between Gold prices in US Dollars (XAUUSD) and US Inflation (USCPI).
In technical terms this graph indicates that 40-years deflationary plateau, and monetary cycle of falling USD rates has almost over, while due to mentioned above reasons, Gold can start its ride to outperform inflation within many upcoming years.
🔜 20+ Year Treasury Bond Market. Perhaps This Is The End US stocks surprised much of Wall Street this year with a strong run that defied decades-high interest rates and recession calls. The rally was fueled by slower inflation and hype over artificial intelligence.
But more recently, the Federal Reserve's unwavering higher-for-longer rate stance and a deepening bond-market rout have had a sobering effect on equities sentiment, with the S&P 500 index halving its year-to-date gains.
Indeed stock valuations are looking increasingly stretched, raising the risk of a correction.
One such indicator in particular is flashing RED - the relative valuation of stocks versus the debt market.
SPX / ICE BofA Corporate Total Return Index
In August this year, the S&P 500 CBOE:SPX climbed to levels last seen during the peak of dot-com boom, relative to an index that tracks the US corporate bond market.
The gauge is still holding near those highs, despite the recent pullback in equities.
The metric last surged this high in the spring of 2000 — and that was followed by a multi-year meltdown in stocks that saw the S&P 500 crash 50% between March 2000 and October 2002.
SPX 50% Decline During 2000-2002
Another indicator that shows the richness of stocks relative to debt is the so-called equity risk premium — or the extra return on shares over government debt, which is considered a safer form of investment. The metric has plunged this year lows unseen in decades, indicating elevated stock valuations.
"Equity risk premium is near its worst ever level going back to 1927. In the 6 instances this has occurred, the markets saw a major correction & recession/depression - 1929, 1969, 99/00, 07, 18/19, present," research firm MacroEdge said in a recent post on X (ex-Twitter).
The so-called equity risk premium (earnings yield minus bond yield) recently fell to a new cycle low and remains well below historical averages. In other words, the stock market has become more expensive relative to the bond market despite the recent pullback.
Meanwhile the main graph (quarterly Div-adjusted chart for NASDAQ:TLT 20+ Year Treasury Bond ETF) illustrates perhaps right there could the end for U.S. Govt Bond Market decline, with Double top as a further projected/ targeted upside price action.
Will all of that bring U.S. stock market to 50% decline like in early 2000s!?
Time will show!
Shelter Inflation. The Tail That Wags The DogInflation is finally cooling off as inflation gradually loosened its grip on Wall Street and the economy in 2023, raising hopes for a gentler Federal Reserve and further gains for the market in 2024.
Stocks rallied to their best 9-weeks stripe over the past 20 years in November and December, 2023 (so-called 'Santa Rally') as investors raised their bets that the Fed is done hiking interest rates to fight inflation.
6Mo USCPI Inflation was at its lowest levels since Covid-19 pandemic in early 2023
Top 4 U.S. stock market Indices were in rally in 2023
The economy has cooled under the weight of rising interest rates, as the central bank intended, but remains surprisingly resilient.
Energy prices are down. Food prices are mellowing out. But the cost of having a place to live is still rising much faster than just about every other essential.
U.S. Consumer Price Index inflation
Headline inflation was up 3.1% from a year ago, and so-called "core" inflation, which excludes volatile food and energy prices, was up 4%. But the cost of shelter, which is the biggest component of the basket of goods the BLS uses to measure the cost of living, was up 6.5%.
"The shelter index was the largest factor in the monthly increase in the index for all items less food and energy," read the Bureau of Labor Statistics report accompanying the latest data on consumer prices.
"The shelter index increased 6.5 percent over the last year, accounting for nearly 70 percent of the total increase."
When the covid-19 pandemic hit, the cost of housing surged as those who could afford it sought out bigger homes and many city-dwellers transitioned to the suburbs.
What goes into Consumer Price Index
That and a glut of savings unhindered by low interest rates combined to exacerbate what had been a long-simmering Housing crisis the U.S.
But now that baked-in price hikes and rising mortgage rates spurred by tightened Federal Reserve monetary policy have put a bit of a damper on things, the housing market is also starting to cool.
U.S. Single Family Home Prices in "Bubble Mode"
30Yrs Fixed Mortgage Rate is at 20Yrs Highs.
30Yrs Mortgage Annual Payment U.S. Single Family Home, only Interest.
Housing prices tend to be “much stickier” than most costs, which means that when they rise we feel it more - and for longer (read - "for ever").
Housing prices do not compressed like just baked iPhone or iMac later in few years of its release.
- Does all af that mean that pre-covid levels of relative housing affordability are coming back?
- Sure "No". But at least American wages, which are still rising faster than before the pandemic thanks to increased worker power, will have a little chance to make up some lost ground.
The issue is still Federal Reserve' lagged tightening policy, that is "The Tail That Wags The Dog".
2Yr Yield Rolling Over?And there goes the the 2Yr Yield, it is whimpering.
Unless something happens this is rolling over further.
10Yr Yield had a nice bounce but it is also rolling over.
TVC:TNX is only 33 basis points from normalization!
Short term #yield is looking very weak, 6 month and 1 Yr, not shown.
More info see profile...
Yields are in a do or die situationYields are pulling back a bit from the run they had yesterday. It was expected to have a bounce at the support levels.
The 2Yr & 10Yr #Yield both look as if they want to settle a bit but time till tell . We will see how Yield reacts over the next few days. It is important as a crashing yield can mean higher prices all across the board in many assets.
We've stated before that they CANNOT lower rates but at the same time CANNOT raise them. Seems as if they are playing around a bit providing liquidity to keep markets propped up a bit AND they may keep rates steady or just have 1 rate drop, before election.
TVC:TNX
Interest Rates bounce at support level!And there they go!
The 2Yr bounced right at the support level, AGAIN
It is forming lower highs though.
10Yr #yield looks a bit weaker that its counterpart. TVC:TNX
In reference to the #interestrate post after the one quoted...
The weekly up trend is NO LONGER BROKEN!
TVC:VIX not moving much, interesting.
Bond Yields about to crater?GOOD MORNING!
The 2Yr & 10Yr have broken the triangle pattern we posted on long ago.
The TVC:TNX (10Yr) has gone lower compared to the 2Yr in the same time frame.
Again, natural normalization is still out the window! What does this point to?
Will fed do what they are good at & mess it up again?
---
Now look @ the 10Yr on a weekly chart!
AH HA! Are Bond #yields about to crater???
Stock Market vs Govt Bond Market. At the Dawn of ChangesIt's been 3 months or so since the late March quarter bullish exuberance took the stock market, Ethereum (ETHUSD), Bitcoin (BTCUSD), other crypto assets to their new 52-week and all-time highs.
This is now changing, while the stock market and cryptocurrency markets have stopped making new highs, despite the fact that Roaring Kitty is once again deafening everyone with her phenomenal calls.
Quite high inflation reports for the first quarter of 2024 became a kind of “cold shower” both for the market and for expectations of a possible reduction in interest rates, while the markets have been living this still unfulfilled dream for almost the last year and a half.
The Federal Open Market Committee is unlikely to adjust rates at its upcoming next meeting on June 11-12.
In any case, the prospect of any immediate rate adjustments is estimated at a modest 0.1 percent.
It has been nearly a year since the FOMC last raised the federal funds rate to its current target range of 5.25% to 5.5% in July 2023. And while FOMC members have signaled that labor market weakness could force them to cut interest rates, the labor market remains broadly resilient and unemployment low.
Fixed income markets are forecasting that September could be the first interest rate cut of the cycle. However, this is not certain as the estimated odds are currently around 50%. And again, these forecasts implied by the market can quickly adapt to economic news, and again - turn out to be unfulfilled dreams, just like the dreams of rate cuts that, as discussed above, markets have been living with for the last year and a half.
The main technical chart is the ratio, between iShares Core S&P 500 ETF (IVV) that is similar to mostly known SPDR S&P 500 ETF TRUST (SPY) on the one hand, and Ishares 20+ Year Treasury Bond ETF (TLT) on the other hand. Both ETFs (IVV, TLT) were taken in "Total return" format.
In technical terms, the graph indicates on Bullish upside channel, as right here we're near its upper line, exactly like 17 years ago in second quarter of 2007.
Auxiliary RSI(14) chart indicates also that Stock/ Bond ratio is too overheated in favor to stocks.
The idea should not be seen as a call for immediate action.
However, it is wise to keep in mind that investing in stocks can seriously underperform Govt Bonds in the medium to long term.
Interest Rates look decently strongThe 2Yr yield has paced itself recently.
The 10Yr #yield is picking up steam.
Both went from a bearish moving average crossover, circles, to a bullish
(Data not seen here, more info in profile)
2Yr is almost @ last years bank failure rates.
10Yr has been trading mostly above.
Weekly
2Yr looks like it wants to skyrocket, if breaking out of the ascending triangle pattern.
10Yr has been treading higher, along its trend line. TVC:TNX
Fed is in a catch 22. Cannot raise rates, more things will break BUT it but cannot lower, inflation.
Golden Doomsayer judgment is that inflation still highGold prices traded higher midafternoon on Wednesday as a report showed US inflation is still high.
Gold for June delivery was last seen up, again near US$2,400 per ounce.
The US Bureau of Labor Statistics on Wednesday reported the April consumer-price index rose by 0.3% from March.
Shelter, gas prices remain sticky.
Notable call-outs from the inflation print include the shelter index, which rose 5.5% on an unadjusted, annual basis, a slowdown from March. The Shelter index (the largest US CPI component with near 32% weight) rose 0.4% month over month and was the largest factor in the monthly increase in core prices, according to the BLS.
Sticky shelter inflation is largely to blame for higher core inflation readings, according to economists.
In technical terms, Gold prices are on positive path, firmly above 26- and 52-weeks SMA, while 50/200-weekly SMA Golden Cross that occurred in 2017, still works pretty well, helps year after year to robust gain in yellow metal.
Technical perspectives are near 2550 and 2800 per XAUUSD ounce in this time.
🎲 Interest Rates. To Cut, or not to Cut. That is the questionJamie Dimon Sees ‘Lot of Inflationary Forces in Front of Us’, as in recent interview to Bloomberg JPMorgan CEO has warned for months that rates could stay high.
Jamie Dimon said he’s still more worried about inflation than markets appear to be.
The JPMorgan Chase & Co. chief executive officer said significant price pressures continue to influence the US economy and may mean interest rates will be higher for longer than many investors are expecting. He cited costs linked to the green economy, re-militarization, infrastructure spending, trade disputes and large fiscal deficits.
“There are a lot of inflationary forces in front of us,” Dimon said in an interview on Bloomberg Television Thursday. “The underlying inflation may not go away the way people expect it to.”
The S&P 500 and Nasdaq 100 closed at record highs Wednesday amid optimism over monetary policy easing after a measure of underlying US inflation cooled in April for the first time in six months. Dimon said that markets have been healthy for a while, but that doesn’t necessarily predict the future.
“If you have higher rates and — God forbid — stagflation, you will see stress in real estate and leveraged companies, and private credit,” Dimon said.
“Stocks are very high, and I think the chance of inflation staying high or rates going up are higher than people think,” the CEO said. “My view is whatever the world is pricing in for a soft landing, I think it’s probably half of that. I think the chances of something going wrong are higher than people think.”
The CEO has been warning for months that inflation could be stickier than many investors are predicting, and wrote in his annual letter to shareholders that his bank is prepared for interest rates ranging from 2% to 8% “or even more.”
Dimon said that “a lot of happy talk” is why markets aren’t pricing these elements in.
Even though a bigger surprise would be higher rates, Dimon said that geopolitics could create the “main stress that we’re worried about” amid the impact those dynamics have on oil and gas prices, trade and alliances. With war in Ukraine, the situation in the Middle East, tensions in North Korea and the use of nuclear blackmail, the geopolitical situation is “very tense,” he said.
When it comes to China, the right thing for America is to “fully and deeply” engage, he said. Still, the fragile relationship between the two countries makes banking in the country — where Dimon said JPMorgan has roughly 1,500 multinational clients — a riskier prospect.
“They’re not leaving China, so we’re going to serve our clients there, we’re just much more cognizant the risk is higher,” he said. “You look at China from a risk-reward basis, it used to be very good, it’s not so great any more.”
Basel III
The financial world has been in a heated debate over US proposals tied to what’s called the Basel III Endgame — an international regulatory overhaul initiated more than a decade ago in response to the financial crisis of 2008. US regulators have decided to adjust the original proposals following substantial backlash. Dimon reiterated his comments that the proposals are excessive.
“I would love to know what the end game is,” Dimon said. “Regulators should answer the question: What do you want — How do you want the system to work?”
Uncertainty pushes Gold prices (XAUUSD) more higher, later than The US Bureau of Labor Statistics on Wednesday reported the April consumer-price index rose by 0.3% from March.
Shelter, gas prices remain sticky.
Notable call-outs from the inflation print include the shelter index, which rose 5.5% on an unadjusted, annual basis, a slowdown from March. The Shelter index (the largest US CPI component with near 32% weight) rose 0.4% month over month and was the largest factor in the monthly increase in core prices, according to the BLS.
Sticky shelter inflation that was one of the main reason of 2007-09 Financial crisis is largely to blame for higher core inflation readings, according to economists.
The main technical graph is an inverted (normalized) chart for expected Federal funds rate at mid-March 2025, based on respective Mar'25 FedFunds Futures Contract (ZQH2025).
Following the upside trend, as well as forming reversed Head-and-shoulders structure, the nearest target can be around 8 1/4 - 8 1/2 over the next 12 months.
Historical backtest analyses says, this scenario is not a nonsense, as in early 1980s the difference between US 10-Year T-Bond rates and US Interest rate has been already hugely negative at similar market conditions (fighting against non-stop inflation).
Let's see what is next in nowadays..
Long 10Y, Short 2Y on Yield Curve NormalisationWorld's most important and the largest financial market is the US Treasury. Annual issuance of U.S. Treasuries has exploded. A record USD 23 trillion of treasuries were issued in 2023.
This market is experiencing gradual but notable shifts due to the Federal Reserve (Fed) recent tapering of quantitative tightening and the Treasury buyback. Collective impact has led to demand divergence across different maturities.
The yield curve starting to normalize once more. Economic outlook impacts the yield curve. Not only that, the Fed’s quantitative tightening (“QT”) campaign also has an enormous influence.
At its most recent FOMC meeting, Chair Jerome Powell stated that the Fed would start to slow its balance sheet runoff. The runoff results in supply contraction enabling greater demand for long-term treasuries and a subsequent yield curve normalization.
Runoff refers to the reduction in Fed’s balance sheet as they opt to let their treasury holdings mature without renewing them. This activity leads to a supply contraction.
RECENT HAWKISH FED MEETING CAME WITH A CAVEAT
Since 2022, the Fed has been engaged in a QT campaign. Raising rates is its primary tool. Balance Sheet reduction is an additional strategy to manage monetary environment.
The Fed first announced that it would start to reduce holdings of US treasuries at a fixed pace at its May 2022 meeting. The pace of reduction accelerated as Fed stepped up QT. Treasury runoff has continued at a fixed pace since then.
At the April FOMC meeting, Fed announced its decision to slowdown the runoff. In other words, Fed would start to let treasuries to mature at a slower pace.
Starting from the first of June, the Fed will decrease the maximum amount of treasuries that can mature without being replaced from USD 60 billion per month to USD 25 billion.
Fed’s outlook on rate cuts was hawkish. But its resolve to taper runoff is dovish signalling the Fed’s end of QT campaign through balance sheet reduction. Treasury runoff tapering impact will be noticed additional liquidity before rate cuts arrive.
HOLDINGS & RUN-OFF IS AIMED AT LONG-TERM TREASURIES
Fed’s QT via treasury holdings is implemented through the non-renewal of existing holdings.
Crucially, the impact of letting treasuries mature is more pronounced on long-term treasuries than short term ones. As short-term treasuries mature more often, the impact of this run-off on near-term treasury demand is limited.
In contrast, the impact on long-dated expiries is more pronounced. Analysing the cumulative run-off since May 2022, the largest impact on long-term treasuries has been on 5 to 10 years category which consists primarily of 10-Year notes. This run-off has been particularly high over the last few months. On the contrary, the holdings of 10+ year treasuries have increased.
Source – Federal Reserve
TAPERING RUNOFF SUGGESTS IMPROVEMENT IN LONG-TERM TREASURY DEMAND
Impact on benchmark 10-Year treasuries will be most pronounced as the Fed moves to slow the pace of its runoff. Longer maturities have lagged near-term ones at recent auctions. It was most apparent at the latest auctions.
The 10-Year treasury auction raised USD 42B, that is far higher than the average over the last twelve auctions at USD 31B. While the bid-to-cover was higher than the previous auction in April, it was below the average over the last twelve auctions. Indirect bidding was below average at 65.5%. Overall, this suggests an unimpressive result.
In sharp contrast, 3-Year treasury auction showed strong demand. It raised USD 58B, the highest since 2021. Bid-to-cover was higher than the last auction. Non-dealer bidding was also above average at 85.1% (81.7% average). Similarly, the Treasury 5-Year auction raised USD 70B with an above average non-dealer bidding. Both 3-Year and 5-Year auction results were much stronger.
As observed through the CME TreasuryWatch Tool , the demand for 2-year treasuries has been noticeably higher, as suggested by the bid-to-cover ratios, compared to 10-year and 30-year treasuries.
Source – CME TreasuryWatch
FED’S TAPERING TO FUEL 10Y SPREAD TO OUTPERFORM 5Y SPREAD
Yield curve is normalizing once more following the decline in the 10Y-2Y spread at the start of 2024. This trend is likely to continue as yields for longer dated maturities rise higher than near-term maturities.
Mint Finance highlighted previously that the 5Y-2Y spread is likely to outperform the 10Y-2Y spread. However, as Fed starts to taper its balance sheet run-off, the impact is likely to be felt strongest at the 10Y maturity allowing demand for these treasuries to rise once more.
HYPOTHETICAL TRADE SETUP
Fed’s balance sheet runoff slowdown and the underperformance of the 10Y-2Y spread relative to the 5Y-2Y spread, the 10Y-2Y spread has potential outperform in the near term as the yield curve turns to normalcy.
To harness gains from this normalization, investors can opt to execute a spread trade consisting of Yield futures.
CME Yield futures are quoted directly in yield with a one basis point change in the yield representing a P&L of USD 10. As yield futures across various maturities represent the same notional, spread P&L calculations are equally intuitive with a one basis point change in the spread between two separate maturities also adding up to a P&L of USD 10.
• Entry: -32.3 basis points
• Target: -28.3 basis points
• Stop Loss: -35.3 basis points
• Profit at Target: USD 400
• Loss at Stop: USD 300
• Reward to Risk: 1.3x
MARKET DATA
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Volmageddon. Please Buckle Up. The Plane Will Be Landing SoonStocks are vulnerable to a 5% 'air-pocket drawdown' as greedy traders short volatility.
Tuesday's stock-market pullback on February, 13 after a hot inflation report actually showed us something else about the market.
It turns out that it did… an overcrowded short side of the options market which was reminiscent of the 2018 and 2020 'Volmageddon' events.
ProShares Short VIX Short-Term Futures ETF AMEX:SVXY graph says selling volatility is on the hot spot, like four and six years ago, in 2020 and 2018 respectively.
The "Volmageddon" episode happened six years ago after traders piled into a bunch of ETFs that were designed to return the inverse of market volatility (essentially betting on a calm market). And when volatility went up in February 2018 and in February 2020, it tanked those strategies, sending the S&P 500 down more than 10% in two weeks.
Investors appear to be taking risky bets again, specifically in VIX futures, which are assets that let investors bet on future volatility. As VIX futures expire, the S&P 500 is seeing stronger price reactions.
Based on the magnitude of the move in VIX futures, there is an increasing threat that the rising level of greed in the 'short-volatility' trade, similar to what we saw in 2018 and in 2020, could result in an air-pocket drawdown of 5% or more in the S&P 500, to 4800 points respectively.
The short-volatility trade became very popular strategy after 2010 when volatility was low, and traders could make money betting against market turbulence.
The Cboe Volatility Index, which is also dubbed as the TVC:VIX or the market's "fear gauge," is sitting around 14, near historical lows.
The rebound in interest in short-volatility strategies is once again posing a risk to the broader markets here as a negative catalyst can clearly spark a momentous, derivatives-driven selloff in the broader stock market like that which we saw in 2018 and in 2020.
It's not a major concern right away as volatility upticks have been small, and the S&P 500 has remained resilient. The market shrugged off Tuesday's pullback quite fast.
But it's worth keeping all your eyes on as all 2024 progress can be erased shortly.
Going forward, these expirations will remain dates to keep in mind as the threat of volatility will be elevated as we move further into 2024.
Technical graph for CBOE:SPX says we are still in the upside channel since Q4'22, near its upper line, with further perspective opportunities to erase 2024 gain, shrugging back to mid-line around 4800 points.
Market breadth says also there're huge divergence in CBOE:SPX and in NASDAQ:NDX all the 2024, as 50-days indicators move firmly down all the year, while indices are still up so far.