Bond Traders Have Lots of Reasons to Sell (at Least for One Day)

Traders in the world’s biggest bond market are a fickle bunch.

Less than three weeks ago, the 10-year Treasury yield was flirting with 2 percent, making forecasts for higher interest rates look silly. It’s abruptly reversed course, surging as much as 8 basis points Wednesday to 2.31 percent, the highest since Aug. 1, with strategists like William O’Donnell at Citigroup Inc. eyeing 2.4 percent as the next stop. At least one investor, Bob Michele at J.P. Morgan Asset Management, is calling an end to the Treasury bull market.

Even the 30-year yield, which resisted a selloff after the Federal Reserve’s meeting last week, broke through its 100-day moving average for the first time in nearly two months. So there goes “the one Treasury benchmark where the bull trend held,” O’Donnell said.

It’s easy to justify selling Treasuries at the moment. President Donald Trump is preparing to lay out his tax-cut plan. The market-implied odds that the Fed raises rates again by year-end are up to about 70 percent. The U.S. is issuing $62 billion of fixed-rate notes in the next two days as the Kingdom of Saudi Arabia also borrows. The market’s inflation expectations over the next 10 years are the highest in four months.

The question on everyone’s mind, in a year in which the bond market has defied expectations and held to its narrowest range in a half-century: Can this last?

“We’re skeptical of the longevity of the optimism,” BMO Capital Markets strategists Ian Lyngen and Aaron Kohli wrote in a report. The tax proposal may just be “a more exacting version of Trump’s tax reform ‘wish list’ that has been floated several times. It’s always folly to presume that precision implies accuracy and we fear that’s what the markets are currently trading.”

Others are focusing more on Fed policy. Chair Janet Yellen said this week that officials won’t necessarily delay rate hikes until inflation is back to their 2 percent goal. That follows the announcement last week that the central bank will begin winding down its $4.5 trillion balance sheet next month.

Take the Plunge

“What I heard her say is she is taking the plunge all the way,” Michele, who oversees $470 billion as head of global fixed income, currency, and commodities at J.P. Morgan Asset Management, said in a Bloomberg Radio interview. “And it’s not just one path. It’s not just raising rates or running down the balance sheet. It’s both of those things. She wants to get started on that path of normalization.”

As Michele sees it, the Treasury bull market is over, but the upward move in yields won’t be dramatic until a few months into 2018. He says bond buying from the European Central Bank and the Bank of Japan will “cushion” U.S. markets.

“Spring of next year -- that’s when you are going to see the bear market take hold,” he said. “This path to normalization is all about a bear market.”

For now, bond bears are ascendant, though they’re also at risk after yields climbed so quickly. Based on relative-strength-index analysis, 10- and 30-year Treasuries are the most oversold since July after the lurch higher in yields. That previous episode paved the way for a monthly gain in August that was the biggest since June 2016.

So for all the dip buyers out there, convinced that the bond bull market is still intact, now’s your chance to step up.

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