After a painful operation, large investors insisted on betting on bonds


U.S. Treasury Update

Heavyweight bond investors insisted on betting on US government bonds, saying that the continued rebound gave the false impression that they were deeply worried about the economic outlook.

Fund managers such as BlackRock and JPMorgan Chase Asset Management continue to bet that U.S. Treasury yields will rise even after falling from the highs reached earlier in 2021.

Wall Street analysts have also joined them. They predict that the US 10-year Treasury bond yield will rebound to 1.8% by the end of the year, from the level of 1.285% last Friday. Treasury bond yields are inversely proportional to prices.

“We still believe that the restart is real and the economy is recovering,” said Scott Thiel, BlackRock’s chief fixed income strategist. “In the current environment, the yield on Treasury bonds is too low. The market is too pessimistic about the economic outlook.”

Investors such as Thiel acknowledged that the return of the Covid-19 case has eroded some of the optimism in the bond market, which contributed to the massive sell-off earlier this year. But they believe that the central bank’s relentless purchases and the bearish consensus of investors have created an environment where there are almost no new sellers on the table.

This exaggerated the decline in yields, pushing the U.S. benchmark interest rate down to 1.13% this week, and then rebounded higher. The equivalent of Germany’s yield hit a negative 0.44%, which is also a five-month low.

“On the surface, this is consistent with the economic downturn,” said Antoine Bouvet, senior interest rate strategist at ING. “I’m not sure this is really the market’s thinking. You just have some moderate doubts about the strength of the recovery, which means that while the central bank is still hoarding most of its assets, the demand for safe assets will increase. This is it. The explosive formula behind one move.”

The Fed has pledged to buy $120 billion in U.S. Treasury bonds and agency mortgage-backed securities every month until it makes “substantial further progress” in achieving its goal of a more inclusive recovery. Chairman Jay Powell (Jay Powell) has stated that discussions are underway to reduce the size of these purchases, but there is a heated debate about the timing and speed of the withdrawal. At the same time, the European Central Bank confirmed at its latest policy meeting this week that it will continue to buy 80 billion euros of bonds every month, at least until September.

Citi’s interest rate strategists said that due to more outstanding debt maturing compared with previous months, the demand from the central bank was accompanied by a decrease in the net supply of US Treasuries in June. Although many investors have held short positions for several months, they are unwilling to increase the size of these positions by selling more bonds when the market turns against them.

A weekly customer survey conducted by strategists at JPMorgan Chase shows that since mid-June, investors have reduced their negative bets on U.S. Treasury bonds. But the remaining short position—a net 20% of investors this week—is still large by historical standards.

Iain Stealey, chief investment officer of fixed income international at JP Morgan Chase Asset Management, said that he expects the yield on the US 10-year Treasury note to rebound to between 1.5% and 2% by the end of the year. But for now, the company has not increased the size of its short government bond positions.

He said: “Before taking this move, it feels that it is not the right approach,” he said, “Before we do this, I would be more willing to see a turnaround in the market.”

Morgan Stanley’s global head of macro strategy, Matthew Hornbach, said that new evidence shows that the economy is recovering strongly and may begin to reverse the decline in yields.

He said: “Economic data is definitely a factor that I expect to catalyze the continued rise in interest rates.” [Fed] At the meeting, the data was very strong and the financial situation was easier. “

10-year government yield (%) The line chart shows that bond yields have returned to their pre-February levels

Further progress in the economic recovery may help balance the Fed’s plan to withdraw support soon. Morgan Stanley predicts that more details will be provided in September to prepare for the start of March 2022.

“Our view is that by the end of this year, the Fed will be closer to the point where they no longer believe that additional easing is needed every month to keep the economy moving toward the Fed’s goals,” Hornbach said. “If this develops as we expect, the interest rate market will trade at higher yields.”

Nonetheless, in the summer months, decisive changes in direction can be difficult to discern, as small trading volumes usually lead to market volatility.

“Liquidity drops to February levels [2021] Even last March,” said a senior trader at a top bond trading bank. “You can’t trade it. It’s just annoying. “

Traders added that the remaining short positions in the bond market may drive further gains in the short term, as loss-making investors admit defeat and liquidate their positions by repurchasing sold Treasury bonds. “Everyone has the same opinion. This is a classic painful deal.”

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