The financial bond market is being destroyed. Is it time to buy?

Financial bond yields rose to a post-pandemic high last week, expanding the bear market that began last August. The 10-year note closed at 1.62% on Friday, up more than 0.70% from the start of the year. There are plenty of reasons for the post-election move in higher interest rates, and another rise over the next year is still a call for consensus from most economists. However, predicting the end of the bond market in bears is much more challenging.

What are the major forces driving higher yields, and when could they stop?

Economic Growth

The economy is the most critical part of the market. As the economy expands, bond yields tend to rise. And right now, the economy is thriving. With the majority of Americans likely to have access to vaccination before May 1, the opening of the service division is just around the corner. Oxford Economics argues that the major fiscal pressure coupled with improving health conditions and rapid vaccinations should support 7% GDP growth in 2021, leading to a year-end unemployment rate of 4.6% and base inflation at 2.4%. Above movement GDP growth can be good for the economy, but it is negative for bonds.

Fiscal Stimulus

In fact, most of the fiscal blockade comes from the 1.9 trillion stimulus measure recently awarded at Biden. The largesse of the plan, which is just coming the service sector to reopen, has encouraged bond investors who fear the rise will lead to higher inflation. With the Biden Administration expected to announce a multi-trillion-dollar infrastructure spending program later this year, investors are worried that the unprecedented level of government support for handling the economy will continue. Additional incentives are negative for bonds.

Treasury provision

In addition to boosting inflation expectations, the spending spree will add significantly to the budget deficit, which needs to be funded by the issuance of government bonds. Bond investors are already showing signs of volatility. Late last month, the Treasury sold $ 62 billion of 7-year pounds of 4.2 bp, making it one of the worst auctions in history. With trillions of outlets later this year and without an increase in QE purchases from the Fed, the supply / demand situation for Finance looks bleak. Estimates for net exports in 2021 peak at $ 1.8 trillion. The supply picture is negative for bonds.

Inflation

Even before the Covid Relief bill passed, the bond market was aggressively priced in anticipation of higher consumer prices. 5-year inflation exchange rates have risen from 1.72% before the election to 2.5% today, above the Fed’s 2% inflation target. Note that the Fed is targeting a basic PCE, which typically runs around 0.30% lower than the main CPI inflation on which the exchanges are priced. Thus a balance of core CPI of 2.5% equates to a basic PCE expectation of 2.2%. Rising commodity prices in everything from oil and gas to scrap steel and tin indicate higher entry costs, some of which are likely to pass through to consumers. Higher inflation is expected to damage bonds.

Financial Position

In a recent television interview with the Wall Street Journal, Chairman Fed Powell confirmed that he believes inflation will not be a problem and that any spikes will be temporary without second-round effects. He did not appear to be concerned about the rise in bond yields unless it led to “continued tensions in broader financial conditions.” The strength of the stock market has outweighed any tensions in financial conditions stemming from higher bond yields. The current conditions are still very encouraging and are negative for bonds.

Fed Policy

Given the Fed ‘s zero interest rate policy and the continued purchase of $ 120 billion of government bonds and MBS, it is difficult to say that the central bank is anything but appropriate. But the building will eventually come to an end, and the affiliate market knows it. Some expect a tapering bond to begin later this year. Powell’s criteria of “further major progress” toward his goals can be achieved faster than expected.

We could get an early glimpse of changes in the outlook this week when the FOMC releases the latest economic forecasts and the flat-rate forecast “dots.” Several major banks, JP Morgan among them, predict that the mid-dot for 2023 will feature a single hike, up from no walk in the last forecast from December.

In the meantime, some bond investors are hoping the Fed will intervene to reverse the jump in rates. Such an intervention could involve another “Operation Twist” where the Fed would sell short-term securities to buy longer bonds. Since Chairman Powell has just told us that they are not afraid of what is going on in the bond market, it is hard to believe that the Fed will take further mitigation measures at this time.

Another uncertainty that hangs on the market is whether policymakers will extend the rule expiring on March 31 that will allow bank-owned companies to restrict U.S. finances and investments that are held by the Fed from SLR calculations. If the exemption is not extended, banks could step away from intensive balancing intermediary activity and provide some market support.

Overall, the current Fed policy is positive for bonds, but near-term changes will tend to be negative for bonds.

Location

If there is anything positive you can say about the outlook for bonds, the broad consensus view is that the same bond yields can go higher. Short positions in futures contracts are at a higher level, and most economists expect yields to move higher. There is a lot of pent-up demand for long-term finances that will eventually emerge. Many large pension funds with defined benefit obligations, for example, eventually redistribute out of allowances and into long-term bonds to protect their debts. The average funding ratio has improved in the last quarter thanks to the strong stock market and higher interest rates, so it appears that LDI hedge activity is not that far off. But pension money is not dumb. They are aware of the procurement picture. With a couple of trillions of supplies coming over the next year, why rush to buy today?

However, not all market participants are negative on bonds. One person who did not buy into the Guggenheim Partners CIO promotion rate statement is Scott Minerd. It remains bullish on the market and expects to remain so until the lower 35-year move in 10-year interest rates is broken, which is not yet happy. He projects that the next phase of the bull market could bring the 10-year rate as low as -0.5% in 2022.

The fact that most people saw his prediction as a borderline coward goes a long way in telling you the level of condemnation of the bond bears. Looking at the flat rates in Europe, negative rates in the US are not so far from an opinion. Maybe? It’s not possible, why not? The neglect towards the current link market is, in some ways, very optimistic.

Time to buy?

Not yet. Large net supply, faster-than-expected economic growth, additional fiscal stimulus, the inflation forecast, and the eventual removal of Fed accommodation may keep investors on the sidelines to whether the basic and technical picture for the link market will improve. With 10-year yields adjusted for inflation still at 0.65% negative, it is difficult to argue that bonds are cheap, even after the latest backlash in yield.