The $14 trillion bond market has caught Wall Street off guard


face palm shocked sad trading floorLuke
MacGregor/Reuters

  • The $14 trillion Treasurys market was rattled this week
    by news from several central banks. 
  • Investors were led to believe that Japan, China, and
    the Eurozone could be slowing their bond purchases.

  • “None of these developments were priced into the
    market as interest rates rose in response,” analysts at Bank of
    America Merrill Lynch said.

  • But a strong auction for Treasurys this week, and
    misinterpretations of what China and Japan signaled, indicated
    there’s still a healthy appetite for US debt. 

The $14 trillion market for US government debt heard a
number of loud warning shots this week. 

On Tuesday, they came from the Bank of Japan, which said it
was cutting purchases of its government
bonds. 

On Wednesday, they came from senior
Chinese government officials cited by
Bloomberg
, who reportedly recommended  slowing or
stopping the buying of Treasurys after a review.

And on Thursday, the European Central Bank’s meeting
minutes suggested the bank, too, was swaying towards slowing its
bond purchases. 

“It seems that we are getting almost daily reminders that
key global central banks are about to change policies in ways
that are unfavorable to US fixed income,” said Hans Mikkelsen, a
credit strategist at Bank of America Merrill Lynch, in a note on
Friday.

“None of these developments were priced into the market as
interest rates rose in response,” Mikkelsen added.



Screen Shot 2018 01 12 at 12.35.37 PM

Bank of America Merrill Lynch

When bond prices fall, their yields rise. And this week,
concerns about big investors dumping US Treasurys sent the
benchmark US 10-year yield to its highest level since
March.

‘This isn’t the bear market’

But there are a few things that the news, and the move in yields,
did not mean.

It didn’t signal the end of the three-decade bull market in
bonds, according to Jeff Gundlach, the founder of DoubleLine
Capital.

“The venerable Bill Gross said bonds are now in a bear market,”
Gundlach said during a webcast, referring to the Janus Henderson
investor’s
comments
. “I think he’s a little early on that. I think we
need 2.63% to go and we need this trend line on the 10-year
treasury to give way.”

Matthew Hornbach, Morgan Stanley’s global head of
interest-rate strategy, took issue with how some investors
interpreted Bloomberg’s report on China. 

“This isn’t the bear market you’re looking for,”  Hornbach
said in a note on Thursday. “You can go about your business.”

He did not expect China to stop buying or start selling
Treasurys, since the yields on bonds in other major economies
that would be just as easy to trade are rising at a slower
pace. 



Screen Shot 2018 01 12 at 12.04.34 PM

Morgan
Stanley

It’s also possible that Chinese officials used the headlines only
to
threaten the US
ahead of the Commerce Department’s decision
on whether or not to impose a tariff on steel and aluminum
imports. 

“Given recent comments from the administration regarding trade,
we are more inclined to see this as a political move,”
said Priya Misra, the head of global rates strategy at TD
Securities, in a note.

This week, foreign central banks showed their continued appetite
for US Treasuries during an auction for 10-year notes. Indirect
bidders, a group that includes central banks and large investors,
scooped up 71.42% of the $20 billion worth of 10-year notes
auctioned in their strongest participation since August 2016,
Bloomberg data showed.

No change

And traders may have misunderstood the Bank of Japan’s
announcement altogether. 

In 2016, it introduced a program called yield-curve control. This
involved keeping the yield on its 10-year government bonds near
0% and would require the bank to slow its purchases
anyway. And so at best, the announcement this week was a
change in tactics, not policy, according to Marc Chandler, the
global head of currency strategy at Brown Brothers
Harriman. 

“Rather than a new policy of covert tapering, the fewer JGB
purchases, gross and net, is the consequence of the previous
policy shift,”  Chandler said. “That shift had signaled the
move away from targeting the balance sheet itself to targeting
interest rates. Therefore, we are reluctant to recognize that
[it] marks some kind of shift in policy.”

Beyond what central banks are doing, interest rates are also
driven by inflation expectations. “Fundamentals of inflation
do not justify much higher rates,” Misra said. 

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