(Bloomberg View) -- The bond market can't catch a break. For much of Wednesday morning, anticipation was high for the U.S. Treasury Department's auction of $24 billion in 10-year notes. No less than the top-ranked interest-rate strategists at BMO Capital Markets predicted the offering "should find good demand" given that yields had risen to a four-year high above 2.8 percent. Alas, it was not to be.
About 15 minutes before the deadline to submit bids of 1 p.m. New York time, the news broke that Senate leaders agreed on a two-year budget agreement. Bond traders were spooked by word that the deal would provide almost $300 billion in additional spending. That's the last thing they wanted to hear. After all, they are already being asked to put up more cash to finance the government, which is forecast to at least double its debt sales this year to more than $1 trillion -- the most since 2010 -- to make up for the lost revenue from the tax cuts. The prospect for rising supply is one reason why 10-year yields have risen from less than 2.05 percent in September. Demand was the worst in five months for an auction of 10-year notes, with the BMO strategists calling the results "soft." FTN Financial's strategists said there was "not a sign of broad participation."
The results rippled through the markets, with stocks giving up their gains and the dollar soaring on speculation the additional fiscal spending might cause the Federal Reserve to step up the pace of interest-rate increases to make sure inflation doesn't get out of control. "The global bond bubble is leaking air and ANY asset, particularly stocks, that uses the cost of money to price, thus is vulnerable too," Peter Boockvar, the chief financial officer at Bleakley Financial Group, wrote in a research note after the auction.
THE DOLLAR PERKS UP
The Bloomberg Dollar Index hits its highs of the day after the budget deal. Currency traders are starting to gravitate to the greenback on the notion that more the fiscal spending will cause inflation to accelerate, especially with the unemployment rate poised to fall below 4 percent, wages rising at the fastest pace since 2009 and the economy humming. All that could cause the Fed to lean toward raising rates four times this year, though the market is only pricing in a bit more than two increases. Higher rates would pressure Treasury yields higher, making the debt more attractive to global investors than what they can get just about anywhere else. Treasury 10-year notes yield about 2 percentage points more than German bunds. As recently as 2012, there was no difference in the yields. In terms of the dollar, until recently, we "did not think market participants were giving sufficient due to the U.S. fundamentals, and in particular, the widening interest rate differential and the favorable policy mix of fiscal stimulus and tighter monetary policy," the strategist at Brown Brothers Harriman wrote in a research note.
STOCK JITTERS AREN'T GOING AWAY
The S&P 500 Index surged as much as 1.21 percent, appearing well on its way to recovering from Monday's big selloff, before giving up its gains to end down 0.5 percent. All of the weakness came after the bond auction. The prospect that rising Treasury yields will cause borrowing costs to rise and eat into profit margins at the same time a stronger dollar makes exports less competitive is a double-whammy for stock investors. To Doug Ramsey, the chief investment officer of Leuthold Group whose Leuthold Core Investment Fund has beaten 88 percent of its peers over the past five years, bond yields are rising with increasing momentum. This has historically spelled trouble and is in contrast with euphoria years like 2017, according to Bloomberg News' Lu Wang. “What we saw in January was sort of the psychological peak of the entire bull market,” Ramsey told Bloomberg News. He cut his equity holdings just before the selloff. To be sure, stock analysts have been upgrading earnings estimates at the fastest pace in six years, helping to underpin sentiment amid the surge in volatility.
COMMODITIES ARE SLUMPING
Despite the rebound in many risk markets, the Bloomberg Commodities Index of 22 raw materials from crude to copper fell the most since mid-November, dropping 1.15 percent. It has now declined for four straight days and seven out of the last eight. Commodities are largely traded in dollars, so gains in the greenback make it more expensive to buy them. Much of the weakness Wednesday was due to declines in energy and metals. Oil posted the biggest loss in more than two months, with futures sliding as much as 3.3 percent in New York, as record crude production from U.S. fields reignited worries that supplies will swamp demand. Crude output from American wells jumped to 10.25 million barrels a day last week, vaulting the U.S. into the elite of world producers alongside Saudi Arabia and Russia, according to Bloomberg News' Jessica Summers. With production set to climb even higher later this year, the Saudi- and Russia-led alliance of other major suppliers will come under renewed pressure to reconsider self-imposed output caps aimed at eroding a glut.
CHILE IS HEATING UP
Chile is quickly becoming the bright spot of emerging markets. Its peso was the world's biggest gainer against the dollar on Wednesday, extending a run that has seen it post steady gains since early May totaling about 14 percent and taking it to its strongest level since May 2015 against the dollar. Only the Czech koruna and Polish zloty have performed better over that time. Chile has benefited from a surge in the price of its main export: copper, which has risen from last year's low of about $5,500 a ton to more than $7,000 recently. The Chilean government said Wednesday that its trade surplus hit $1.21 billion in January, the most since mid-2014. The peso's rally comes as President-elect Sebastian Pinera, a billionaire, prepares to take office on March 11 with a pledge to cut corporate taxes and double economic growth to between 3.5 percent to 4 percent during his four-year term. Analysts surveyed by the central bank have raised their growth forecast for this year in four of the past six months, according to Bloomberg News' Philip Sanders.
TEA LEAVES
The Bank of England takes center stage, with traders looking for policy makers to ratify the market's expectation that the next interest-rate increase will come as soon as May. Traders have ramped up bets for another rate hike after November's tightening that brought the bank's key rate to 0.50 percent, which was the first increase in a decade. The shift from the previous consensus of no move until the end of the year follows upbeat growth and labor-market data, and Governor Mark Carney appeared to offer a less pessimistic view of the economy last week, according to Bloomberg News' David Goodman and Jill Ward. Sterling has been one of the better-performing major currencies in recent months, with the Bloomberg Pound Index rising 5.46 percent since August, topping similar measures for the euro, dollar, and yen.
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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Robert Burgess is editor of Bloomberg Prophets.
To contact the editor responsible for this story: Max Berley at mberley@bloomberg.net.
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