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

01 /

  • Equity outlook: The high cost of global fragmentation for US portfolios

    Quarterly Outlook

    Equity outlook: The high cost of global fragmentation for US portfolios

    Charu Chanana

    Chief Investment Strategist

  • Commodity Outlook: Commodities rally despite global uncertainty

    Quarterly Outlook

    Commodity Outlook: Commodities rally despite global uncertainty

    Ole Hansen

    Head of Commodity Strategy

  • Upending the global order at blinding speed

    Quarterly Outlook

    Upending the global order at blinding speed

    John J. Hardy

    Global Head of Macro Strategy

    We are witnessing a once-in-a-lifetime shredding of the global order. As the new order takes shape, ...
  • Asset allocation outlook: From Magnificent 7 to Magnificent 2,645—diversification matters, now more than ever

    Quarterly Outlook

    Asset allocation outlook: From Magnificent 7 to Magnificent 2,645—diversification matters, now more than ever

    Jacob Falkencrone

    Global Head of Investment Strategy

  • Macro outlook: Trump 2.0: Can the US have its cake and eat it, too?

    Quarterly Outlook

    Macro outlook: Trump 2.0: Can the US have its cake and eat it, too?

    John J. Hardy

    Global Head of Macro Strategy

  • Equity Outlook: The ride just got rougher

    Quarterly Outlook

    Equity Outlook: The ride just got rougher

    Charu Chanana

    Chief Investment Strategist

  • China Outlook: The choice between retaliation or de-escalation

    Quarterly Outlook

    China Outlook: The choice between retaliation or de-escalation

    Charu Chanana

    Chief Investment Strategist

  • Commodity Outlook: A bumpy road ahead calls for diversification

    Quarterly Outlook

    Commodity Outlook: A bumpy road ahead calls for diversification

    Ole Hansen

    Head of Commodity Strategy

  • FX outlook: Tariffs drive USD strength, until...?

    Quarterly Outlook

    FX outlook: Tariffs drive USD strength, until...?

    John J. Hardy

    Global Head of Macro Strategy

  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

Content disclaimer

None of the information provided on this website constitutes an offer, solicitation, or endorsement to buy or sell any financial instrument, nor is it financial, investment, or trading advice. Saxo Bank A/S and its entities within the Saxo Bank Group provide execution-only services, with all trades and investments based on self-directed decisions. Analysis, research, and educational content is for informational purposes only and should not be considered advice nor a recommendation.

Saxo’s content may reflect the personal views of the author, which are subject to change without notice. Mentions of specific financial products are for illustrative purposes only and may serve to clarify financial literacy topics. Content classified as investment research is marketing material and does not meet legal requirements for independent research.

Before making any investment decisions, you should assess your own financial situation, needs, and objectives, and consider seeking independent professional advice. Saxo does not guarantee the accuracy or completeness of any information provided and assumes no liability for any errors, omissions, losses, or damages resulting from the use of this information.

Please refer to our full disclaimer and notification on non-independent investment research for more details.
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-mena/legal/disclaimer/saxo-disclaimer)


Business Hills Park – Building 4,
4th Floor, office 401, Dubai Hills Estate, P.O. Box 33641, Dubai, UAE

Contact Saxo

Select region

UAE
UAE

All trading and investing comes with risk, including but not limited to the potential to lose your entire invested amount.

Information on our international website (as selected from the globe drop-down) can be accessed worldwide and relates to Saxo Bank A/S as the parent company of the Saxo Bank Group. Any mention of the Saxo Bank Group refers to the overall organisation, including subsidiaries and branches under Saxo Bank A/S. Client agreements are made with the relevant Saxo entity based on your country of residence and are governed by the applicable laws of that entity's jurisdiction.

Apple and the Apple logo are trademarks of Apple Inc., registered in the US and other countries. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.