SOS central banks wanted! SOS central banks wanted! SOS central banks wanted!

SOS central banks wanted!

Bonds
Althea Spinozzi

Head of Fixed Income Strategy

Summary:  Yesterday's volatility in the bond market strengthens our belief that central banks' intervention is needed again to avoid another crisis. In the United States, the move up in yields has just started to tighten economic conditions. This week the correlation between Treasury yields and junk bond performance has turned negative, signalling that the selloff might soon leak to risky assets. In Europe, the periphery might soon face problems refinancing its debt as demand for bonds suddenly drops.


Why the Federal Reserve should step in:

Yesterday we saw an incredible move up of US Treasury yields. Ten-year yields went up as much as 1.61% following a weak 7-year auction that saw a high drop in foreign demand in US Treasuries. This is very worrying because the Treasury will need to continue to issue more Treasuries to finance Biden's $1.9 trillion stimulus package, leaving the market wondering whether demand will be able to match the supply? If it doesn't, we might see an acceleration of the selloff in Treasuries that will lead to other meaningful squeezes such as the convexity hedging that we saw yesterday, which ultimately triggered a set of events that led to the spike of US Treasury yields spiking.

1. Real interest rates are on the rise, and financial conditions are about to tighten

Yesterday selloff hit the whole US yield curve. 2 year Treasury yields rose sharply by 5 basis points, the highest since March last year when we were in the middle of the Covid pandemic. Alarmingly though, the spike in yields didn't match a rise in inflation expectation. Actually, the 2-year Breakeven rate has fallen since the mid-February peak.

Source: Bloomberg.

It is very troubling for the Federal reserve to see a rise in real interest rates because it leads to a rise in the cost of capital for corporations, putting pressure on overleveraged zombies. The move up in real rates has been substantial in the past few weeks. We saw 10-year TIPS at -1% in mid-February, going to -0.65% in a matter of days. At the same time, the yield on 30- year TIPS has gone back to positive territory. Unfortunately, this has led to a slight tightening of economic conditions, which could become more pronounced as real rates continue to rise.

Source: Bloomberg.

2. Correlation between yields and junk has turned negative from this week, pointing to a bigger selloff ahead

It is about to become a challenging market for risky assets. While junk bonds have benefited from a strong risk appetite since the beginning of the year, we may be about to see the tide turning. This week indeed had seen the correlation between Treasury yields and Junk bond returns turning negative, exactly as it happened during the 2013 Taper Tantrum when yields were rising, pointing to the fact that it may just be starting to get uncomfortable for risky assets. To learn more about this click here

Reasons why the European Central Bank should step in:

1. The periphery is just about to get into troubles

The ECB's monetary policies were doing well until the reflation trade in US Treasuries provoked a spike in European yields. Although many European sovereigns yields are still trading at historic low levels, one cannot ignore other important signals. Yesterday's Italy 5 year BTP auction was exceptionally weak, registering the lowest bid-to-cover ratio since June.  At the same time, Greeks government bonds fell by more than 3% in just a month. This is about to bring back reminisces from the periphery crisis, which cannot happen while there is no clear path to recovery, and the economy lacks fiscal stimulus.

Source: Bloomberg.

Quarterly Outlook 2024 Q3

Sandcastle economics

01 / 05

  • Macro: Sandcastle economics

    Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.

    Read article
  • Bonds: What to do until inflation stabilises

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain inflation and evolving monetary policies.

    Read article
  • Equities: Are we blowing bubbles again

    Explore key trends and opportunities in European equities and electrification theme as market dynamics echo 2021's rally.

    Read article
  • FX: Risk-on currencies to surge against havens

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperform in Q3 2024.

    Read article
  • Commodities: Energy and grains in focus as metals pause

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities in Q3 2024.

    Read article

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)

Saxo
40 Bank Street, 26th floor
E14 5DA
London
United Kingdom

Contact Saxo

Select region

United Kingdom
United Kingdom

Trade Responsibly
All trading carries risk. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more
Additional Key Information Documents are available in our trading platform.

Saxo is a registered Trading Name of Saxo Capital Markets UK Ltd (‘Saxo’). Saxo is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871. Registered in England & Wales.

This website, including the information and materials contained in it, are not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in the United States, Belgium or any other jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation.

It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo assumes no liability for any loss sustained from trading in accordance with a recommendation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc. Android is a trademark of Google Inc.

©   since 1992