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China is not bond market’s problem

By Dwight Johnston on January 11, 2018 at 8:58 am

After yesterday’s false scare on China, Dow futures are up 40 points in pre-opening trading and bond prices are slightly lower to start the day. Bond prices were higher during Asian trading hours but started to fade as Europe took over. 

An Overblown Story

The 10-year yield came within an eyelash of 2.60% yesterday on the overblown story on China reducing purchases of U.S. Treasuries. It took awhile, but bond traders finally realized this was a non-story. They were further relieved when the Treasury’s 10-year note auction received very strong demand from foreign accounts. The Treasury will auction 30-year bonds today, and traders will be expecting another good auction.

Talking heads on CNBC spent most of yesterday talking about the death of the 30+year bull market in bonds. The obituary was premature, but it doesn’t mean it won’t be used at a more appropriate time and for more appropriate reasons. Traders have yet to come to grips with the tectonic shift in supply and demand coming this year. The Fed will be out of the buying game by the 4th quarter, and the ECB role will be greatly reduced. Even the Central Bank of Japan is rumored to be looking at less accommodation as the global recovering spreads.

Europe will be ramping up bond issuance this year, but it’s nothing compared to the bond issuance ahead for the U.S. Treasury. Net new issuance for the U.S. will likely hit $500-600 billion this year and escalate next year. The only way longer-term rates won’t rise is if inflation falls and the economy weakens.

If longer-term rates do start to rise, the Fed might hold shorter-term rates steady and let longer rates catch up to shorter rates. That steeper curve would be a favorable outcome for credit unions, but it might eventually lead to much higher longer-term rates than are currently being forecast. The bond market has several concerns, but China isn’t one of them.    

In economic news, the headline Producer Price Index fell -.1%, and the core rate also fell .1%. Economists were expecting gains of .2%. This caused a mildly positive reaction in the bond market, but tomorrow’s CPI will be more relevant. If CPI falls as well, one of the bond market’s problems will look a lot less worrisome. Weekly Jobless Claims rose by 11k as seasonal factors and the weather played a role. 

Opening Market Rates

  • 2-year is 1.97%
  • 5-year 2.35%
  • 10-year is unchanged at 2.555%
  • 30-year bond is unchanged at 2.90%.
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