Weak Government Bond Sales Raise Flags Across The Globe
South Africa’s weakest bond auction this year spells trouble for the government’s plans to reduce debt costs. Weak Government Bond Sales Raise Flags Across The Globe
The lowest demand since Dec. 1 raises concerns that the Treasury may struggle to finance its budget deficit in a macro environment of rising global yields and large outflows from the domestic bond market. While debt issuance is above target for this fiscal year, the government decided to keep sale amounts at current levels, reducing only the extra amount investors may buy through a non-competitive auction, further damping demand.
Adding to traders’ concerns was data on Tuesday that showed South Africa’s economy contracted the most in a century in 2020 as restrictions to curb the spread of the coronavirus pandemic ravaged output and disrupted trade.
“When the National Treasury decided to reduce the non-comp optionality but keep bond issuance the same till the end of the financial year, the market perceived this as negative news,” said Michelle Wohlberg, a Johannesburg-based fixed-income analyst at Rand Merchant Bank. “We saw how this played out in today’s auction with bid-to-cover ratios at the lowest we’ve seen this year.”
The primary dealers who buy bonds directly from the government placed orders for 11.5 billion rand ($749 million) of securities at Tuesday’s auction, or 1.7 times the 6.6 billion rand on sale. The sale took place against the backdrop of a selloff by foreign investors, with a 10th straight day of net sales on Monday bringing year-to-date outflows from the bond market to $2.4 billion.
“Although we’ve seen local real-money accounts buy bonds into weakness, it hasn’t been to the same extent that foreign selling has been,” said Wohlberg.
Yields on rand-denominated bonds rose following the debt sale. Those on notes maturing in 2040 were the least in demand at the auction and climbed a sixth day by three basis points to 11.24%. That’s the highest since November.
South Africa Reserve Bank has tempered its debt-buying program, meaning there is now less of a backstop for the country’s yields. Data released Friday showed the bank’s holdings of government securities dropped for the first time in a year, suggesting it has been less active in the secondary market.
EU’s $100 Billion Social Debt Orders Show Immunity To Bond Rout
The European Union’s latest offering of social bonds proved immune to the sudden dropoff in demand that has gripped global debt markets.
The bloc pulled in over 86 billion euros ($102 billion) of orders for a 9 billion-euro sale of 15-year debt via banks Tuesday, to help fund a regional jobs program. The bumper orderbook grew even after the EU cut its pricing, showing investors are still piling into ethical debt.
“I take the swiftness of the process as a sign that there is no real challenge for the EU to get demand,” said Antoine Bouvet, senior rates strategist at ING Groep NV. “It doesn’t suggest that there is much reluctance to pick up duration here.”
The triple-A rated bloc has emerged as one of the most appealing new borrowers, after bidding for its first social bond smashed records last year and a sale in January saw strong demand. The market for sustainable bonds is also burgeoning, with Italy’s debut last week pulling in the biggest-ever green order book.
The broader debt market has seen demand struggle at sovereign auctions, including for U.S. Treasuries and German bonds, sparking the selloff in recent weeks. The EU may have its own appeal, with its debt seen as a potential future rival asset to Treasuries.
The sales for its 100 billion-euro SURE social bond program are just a taster ahead of financing for its 800 billion-euro pandemic recovery fund, a third of which is due to be green debt.
“There is strong appetite for its name out there,” said Piet Christiansen, chief strategist at Danske Bank A/S, who expects another social bond sale by the end of the month.
The bloc cut pricing to 4 basis points below midswaps, from initial guidance of about 2 basis points below. While the order book was “huge,” it’s no longer a “one-way street” in terms of ever-tighter deal prices, said Michael Leister, head of rates strategy at Commerzbank AG.
DZ Bank AG, HSBC Holdings Plc, NatWest Markets, Toronto-Dominion Bank and UniCredit SpA were joint lead managers on the deal. While the orderbook was smaller than a near-record 114 billion euros seen for the same maturity in November, the bloc sold more debt.
Flood of New Debt Tests Bond Market
Supply seen as one factor driving yields higher as investors anticipate economic resurgence fueled by vaccinations and government stimulus.
Some on Wall Street see signs the U.S. government’s extraordinary borrowing spree is starting to test investors’ appetite for new Treasury debt.
Over the past few months, falling bond prices have pushed the yield on the benchmark 10-year U.S. Treasury note from about 1% to more than 1.5%, around its highest level in more than a year. Most investors think the climb largely reflects expectations for a vaccine- and stimulus-fueled economic resurgence that could eventually lead the Federal Reserve to raise short-term interest rates.
Another factor pushing yields higher, many analysts and traders say: the sheer volume of Treasurys now flooding the market—a byproduct of the trillions of dollars the government is spending to support the economy during the coronavirus pandemic.
Net new supply of two- to 30-year Treasurys is expected to reach $2.8 trillion this year, according to BofA Global Research, up from $1.7 trillion last year and around $990 billion in 2019. The Fed, meanwhile, is expected to purchase $960 billion of Treasurys, down from more than $2 trillion last year.
Supply may not be the primary factor driving yields higher. But it has been an accelerant, weighing on the market precisely because the economic outlook has already made investors hesitant to buy bonds, traders say.
“It just makes everything so much worse,” said Daniel Mulholland, a senior bond trader at Crédit Agricole. The size of Treasury debt auctions “are completely out of control,” he added.
Investors pay close attention to U.S. Treasury yields because they help determine borrowing costs across the economy. Investors generally welcome higher yields if they come about slowly and are clearly the result of an improving economy. They tend to be less enthusiastic about the type of sharp rise that has occurred this year, when other factors also seem at play.
One piece of good news for investors is that the Treasury Department may not need to increase the amount of notes and bonds it issues to fund the $1.9 trillion coronavirus relief package that President Biden is expected to sign shortly, analysts said, given its cash on hand and the size of current auctions.
Investors, though, hardly expect any let-up in government borrowing. In recent weeks, congressional Democrats and the Biden administration have signaled interest in another multitrillion-dollar spending package to update the country’s infrastructure. Investors also are on edge about the possibility that the Fed could start scaling back its monthly purchases of Treasurys once the economy picks up momentum, putting even more bonds in circulation.
The impact of supply on Treasury yields is disputed on Wall Street. Some analysts are adamant that it historically has had almost no influence on yields and that growing levels of debt could even push yields lower over the long term by dragging on economic growth.
Still, many say the current situation is unusual and could lead to different outcomes.
In the past, the U.S. has typically ramped up borrowing during economic downturns, when demand for Treasurys from nervous investors is especially strong. That makes it hard to discern any negative effect from increased supply. Now, however, markets are bubbling with optimism about the prospects for a post-pandemic economy.
Some traders and analysts say there has been a clear connection between supply and the recent uptick in yields. They point to Feb. 12, when the 10-year Treasury yield drifted above the top of its previous range of about 1% to 1.2%
The Treasury Department had just sold a record $126 billion in three-year notes, 10-year notes and 30-year bonds over the previous three days. Demand was solid for the first of those two auctions but soft for the 30-year sale on Feb. 11.
Primary dealers, financial institutions that can trade with the Fed and are required to bid at auctions, were left with a relatively large share of the total—an outcome that Jefferies analysts noted at the time did “not bode particularly well for the market” given the likelihood that dealers would try to unload some of their new bonds.
Sure enough, Treasurys—and 30-year bonds in particular—fared poorly the following day. Trading volumes were relatively light for the size of the move, and analysts characterized the rise in yields as more of a buyers strike than a surge in selling—one possibly influenced by the volume of new bonds that investors had just absorbed.
Over the following weeks, yields continued to climb sharply, often with heavier trading. More large auctions arrived in the midst of the selling, including a $61 billion sale of five-year notes on Feb. 24 and a $62 billion sale of seven-year notes on Feb. 25 that analysts described as one of the most poorly received of recent decades. Those only added to the selling, with five- and seven-year yields rising nearly 0.2 percentage point during the week of their auctions—a bigger change than other Treasurys.
Investors get only short rests between auctions. The Treasury sold another $58 billion of three-year notes on Tuesday and $38 billion of 10-year notes Wednesday, with a $24 billion auction of 30-year bonds still to come on Thursday. A year ago, auctions of the same bonds totaled $38 billion, $24 billion and $16 billion respectively.
Supply concerns aside, some investors argue that Treasury yields have climbed too far too quickly based on unrealistic expectations for the U.S. economy. The yield on the benchmark 10-year Treasury note settled at 1.520% on Wednesday, down from 1.545% on Tuesday. Yields fell in the morning after new data showed that inflation remained muted in February and were little changed after investors showed lukewarm demand for the 10-year auction.
Some investors and analysts also say the threat from increased government borrowing and supersize debt auctions might be as much psychological as it is mechanical.
Auctions like the most recent seven-year note sale are “not something we like to see,” said Jim Caron, head of global macro strategies for Morgan Stanley Investment Management’s fixed-income team. So far, he said, the supply of Treasurys has been manageable in his opinion, but “if we see another one of those then I think we start to get more concerned.”
India Cancels Bond Auction To Calm Yields Amid Global Swings
India canceled a scheduled weekly auction of 200 billion rupees ($2.7 billion) of bonds, a move that’s likely to temporarily boost sovereign debt.
The government decided to cancel the auction on review of its cash balances, the central bank said in a statement after close of markets Monday. Some traders had been expecting the decision as revenues improve following an economic rebound from the pandemic.
“Tomorrow the market may open four basis points lower, and will be supported for the next two weeks due to no supply” said Harish Agarwal, a bond trader at FirstRand Bank in Mumbai. “The government has a surplus right now after the advance-tax collections, that’s why they have canceled the auction.”
India had planned record gross market borrowings of about 13.9 trillion rupees for the current fiscal year to March, and about 12 trillion rupees for the next fiscal year. Higher government borrowings and a spike in U.S. Treasury yields spooked the markets, resulting in yields climbing by about 30 basis points since early February.
The yield on benchmark 10-year bonds declined by two basis points to 6.18% on Monday.
They may dip to 6.10% in the short-term, and “then, it all depends on the next year’s borrowing calendar, which is unlikely to give any positive surprises,” said Agarwal.
Bond Traders Go All-In On U.S. Treasury Market’s Big Short Bet
It’s not just in meme stocks that the fate of short sellers is a key theme. Short bets are increasingly in vogue in the $21 trillion Treasuries market, with crucial implications across asset classes.
The benchmark 10-year yield reached 1.62% Friday — the highest since February 2020 — before dip buying from foreign investors emerged. Stronger-than-expected job creation and Federal Reserve Chair Jerome Powell’s seeming lack of concern, for now, with leaping long-term borrowing costs have emboldened traders.
In one telltale sign of which way they’re leaning, demand to borrow 10-year notes in the repurchase-agreement market is so great that rates have gone negative, likely part of a move to short the maturity.
The trifecta of more fiscal stimulus ahead, ultra-easy monetary policy and an accelerating vaccination campaign is helping bring a post-pandemic reality into view. There are of course risks to the bearish bond scenario. Most prominently, yields could rise to the point that they spook stocks, and tighten financial conditions generally — a key metric the Fed is focused on for guiding policy.
Even so, Wall Street analysts can’t seem to lift year-end yield forecasts fast enough.
“There’s a lot of tinder being put now on this fire for higher yields,” said Margaret Kerins, global head of fixed-income strategy at BMO Capital Markets. “The question is what is the point that higher yields are too high and really put pressure on risk assets and push Powell into action” to try and tamp them down.
Share prices have already shown signs of vulnerability to increasing yields, especially tech-heavy stocks. Another area at risk is the housing market — a bright spot for the economy — with mortgage rates jumping.
The surge in yields and growing confidence in the economic recovery prompted a slew of analysts to recalibrate expectations for 10-year rates this past week. For example, TD Securities and Societe Generale lifted their year-end forecasts to 2% from 1.45% and 1.50%, respectively.
Asset managers, for their part, flipped to most net short on 10-year notes since 2016, the latest Commodity Futures Trading Commission data show.
In the days ahead, however, BMO is eyeing 1.75% as the next key mark, a level last seen in January 2020, weeks before the pandemic sent markets into a chaotic frenzy.
A fresh dose of long-end supply next week may make short positions even more attractive, especially after record-low demand for last month’s 7-year auction served as a trigger to push 10-year yields above 1.6%. The Treasury will sell a total of $62 billion in 10- and 30-year debt.
With expectations for inflation and growth taking flight, traders are signaling that they anticipate the Fed may have to respond more quickly than it’s indicated. Eurodollar futures now reflect a quarter-point hike in the first quarter of 2023, but they’re starting to suggest that it could come in late 2022. Fed officials have projected they’d keep rates near zero until at least the end of 2023.
So while the market is leaning toward loftier yields, the interplay between bonds and stocks is bound to be a huge focus going forward.
“There’s definitely that momentum, but the question is how well risky assets adjust to the new paradigm,” said Subadra Rajappa, head of U.S. rates strategy at Societe Generale. “We’ll be watching next week, when the dust settles after the payrolls data, how Treasuries react and how risky assets react to the rise in yields.”
The Bond Market’s Weird And Scary Breakdown Is Still A Riddle
One year on, we’re far from getting to the bottom of that bizarre spike in Treasury yields.
Bond Market: It’s A Mystery
Amid the rash of Covid-19 anniversaries, it was easy to miss that the pandemic’s scariest financial moment just turned one. On March 19 last year, the 10-year Treasury completed a bizarre rebound, hitting 1.27%. On March 9, it had dropped to 0.31%, an all-time low.
A gain of almost a full percentage point in barely a week, against the background of actions meant to keep yields low, qualifies as one of the weirdest moments in financial history. On the face of it, the market looked to have broken down. For some reason there had been massive selling of Treasuries at a time of extreme high risk, which would normally be exactly when investors would be expected to buy.
Getting to the bottom of that accident is proving maddeningly difficult. That is the key point that comes through from a new report, Nothing but the Facts: The U.S. Treasury Market During the COVID-19 Crisis, published by the bipartisan Committee on Capital Market Regulation, or CCMR.
It comes to the disturbing conclusion that there isn’t enough information about this vital market for us to work out with any certainty who sold, or why. That makes it harder to know how to stop another such accident in future.
This is the CCMR’s depiction of what happened. The Federal Reserve was already intervening, even as yields plummeted, and then started making massive extra purchases of Treasury bonds as yields turned around and started to rise. Three separate fresh interventions weren’t enough to bring them back down again.
Bond market volatility peaked on March 19, at a level even higher than the post-Lehman Brothers crisis in 2008. Then, with daily Fed bond purchases of about $70 billion, the Treasury market steadily found a level.
Since then, yields have returned in more orderly fashion to their levels before the pandemic, while the Fed’s daily purchases have dropped from $75 billion to a still very high $3 billion. With a year’s perspective, what happened last March seems even more of an aberration.
How exactly did the market break? The question involves delving into the opaque structure of Treasuries trading, most of which is over the counter. The market is mainly dominated by broker-dealers (big banks), but with an increasing share taken by principal trading firms, which often use algorithms and carry little inventory overnight.
Broker-dealers are executing mostly on behalf of clients, and have to register with the Securities and Exchange Commission. Principal trading firms must also register if they offer to execute trades for others. In practice, principal firms tend to dominate automated trading, while broker-dealers account for the great bulk of voice and manual orders.
Different entities have different reporting requirements, while trading venues have varying policies for disclosing who is active. The fracturing and diversification of the market is in many ways healthy, as it introduces competition and provides investors with a chance to minimize costs. But the effect has been to make an already complicated market opaque. The CCMR’s conclusion is that regulators don’t demand enough information for anyone to know who sold. As the CCMR says in its report:
* Provide regulators with information regarding the identity of PTFs that are not.
* FINRA members, banking entities and investors that trade on manual interdealer platforms and in the dealer-to-client market. Such investors include mutual funds, hedge funds, pension funds, insurers, foreign central banks and sovereign wealth funds, among others. The lack of such information is a critical missing piece in understanding the volatility experienced in the cash Treasury market during March 2020.
What information does exist helps to suggest likely sellers, but it isn’t produced frequently enough to deduce exactly who created the intense selling pressure. The Fed’s quarterly data show that during the first quarter there were big falls in Treasury holdings by foreign investors ($287 billion), open-end mutual funds ($236 billion) and the domestic household and nonprofit sector ($170 billion). But the categories are broad, and it’s always possible that these groups had done most of their selling earlier in the quarter.
Meanwhile, the Treasury Department publishes monthly data on rises and falls in holdings by foreigners. Last March saw big reductions by residents of Saudi Arabia ($25 billion), Brazil ($21.5 billion) and the euro zone ($44 billion). It also has transaction data that show large net sales by residents of the Cayman Islands ($117.9 billion) and the U.K. ($41.5 billion). But again, the data aren’t granular enough to tell us which exact operators with addresses in the Caymans bailed out.
The CCMR suggests that regulators stay their hands when it comes to making potential radical reforms until they have better information. This might strike some cynics as pleading by Wall Street to avoid more regulation. But the CCMR makes clear that the greatest need is to fix the disclosure regime, which has plainly not kept up. That does seem like it should be a priority.
Inflation Breakevens And Oil
Now, for another paradox. Inflation breakevens — the forecast that can be derived from the difference between the yields on inflation-linked and fixed bonds of a given maturity — are at their highest since 2013. That is quite something when the world is still in the grip of a pandemic.