‘Tough Week’ Leaves Bond Traders Girding For Another Key Stretch

The US Treasury building in Washington, D.C., U.S.

(Bloomberg) -- Bond traders who just navigated their rockiest stretch in months will get little respite in the days ahead, which bring the biggest Treasury refunding slate since last year and a pivotal inflation reading.

It's a potentially decisive period for the world's biggest bond market, which has started to lean toward a bet that the Federal Reserve is done hiking interest rates. Buyers emerged Friday on signs US job growth is slowing, pulling yields back down from a test of multiyear highs.

The rally softened the blow of the market's first three-week slide since May. But it was yet another dose of volatility for traders who had already absorbed a surprise Bank of Japan policy shift, the move by Fitch Ratings to downgrade the US and a bigger-than-expected boost in Treasury auctions, all in the span of seven days.

“It's been a tough week,” said Jack McIntyre, a portfolio manager at Brandywine Global Investment Management, who is overweight Treasuries. “Bonds have just moved too much. Next week is going to be very interesting to see how those auctions go, because it could be a sell-the-rumor-buy-the-fact sort of thing,” and the consumer price index report will be “huge in terms of market sentiment.”

The bond market's slide of late is frustrating investors who, according to a JPMorgan & Chase survey, had accumulated the biggest bullish position in more than a decade in June. Meanwhile, it galvanized others, including Bill Ackman, who said he's using options to short 30-year Treasuries, citing factors including the increasing supply.

Auction Test

Yields on 10- and 30-year Treasuries are roughly 20 basis points or more higher than just a couple weeks ago. The question is whether they are high enough to entice buyers as the Treasury sells a combined $103 billion of 3-, 10- and 30-year debt in the days ahead.

This past week proved to be another disappointment for investors who've been waiting for 2023 to deliver on hopes that it would be the “Year of the Bond.” The thought at the start of the year was that the Fed would have pivoted to rate cuts by now, sending yields diving and allowing investors to recoup some of last year's drubbing.

But it has hardly worked out that way, with the Bloomberg US Treasury index sliding the past three months. Fading expectations for a recession are part of what's weighing on the bond market.

This week also delivered more pain to those betting on a flatter yield curve, a trend that had been in place for much of the past few months. The curve quickly steepened this week, extending a move that began when the BOJ surprised markets last week by widening the allowable trading band on the 10-year Japanese government bond yield.

The yield on 30-year Treasuries ended the week above the five-year rate, after trading well below it in early July.

Now the focus shifts to the auctions. The sales start with $42 billion of three-year notes on Aug. 8, followed by $38 billion of 10-year notes and $23 billion of 30-year bonds. The total of this trio, known as the refunding, is $7 billion greater than the round three months ago.

Demand at recent auctions has been tepid. Sales of 10-year notes have “tailed,” meaning they drew higher-than-expected yields, at five consecutive auctions.

On Thursday, the consumer price index is expected to show annual core inflation remained at 4.8%, a level that was eclipsed in 2021 for the first time in decades, keeping traders on edge regarding the Fed's September decision.

With the outlook murky, most investors are opting to stay on the sidelines, said Gennadiy Goldberg, head of US rates strategy at TD Securities.

“From a long-term standpoint, yields are now at the most attractive levels in a very long time,” he said. “What's keeping investors away is the fear that they would get even better levels over the next three to six months.”

What to Watch

Economic data calendar
- Aug. 7: Consumer credit
- Aug. 8: NFIB Small Business Optimism; trade balance; wholesale trade sales
- Aug. 9: MBA mortgage applications
- Aug. 10: Consumer Price Index; initial jobless claims; federal budget statement
- Aug. 11: Producer Price Index; University of Michigan sentiment
Federal Reserve calendar
- Aug. 7: Atlanta Fed President Raphael Bostic; Fed Governor Michelle Bowman
- Aug. 8: Philadelphia Fed President Patrick Harker
- Aug. 10: Bostic; Harker
- Auction calendar:
  - Aug. 7: 13- and 26-week bills
  - Aug. 8: 52-week bills; 42-day CMB; 3-year notes
  - Aug. 9: 17-week bills; 10-year notes
  - Aug. 10: 4- and 8-week bills; 30-year bonds