If you needed any more convincing that Treasuries were mostly ignoring economic news and trading on the latest coronavirus headlines this week has provided plenty of evidence. From blowout Empire Manufacturing numbers, to solid housing starts and permits, to a steamy PPI reading, to a blockbuster Philly Fed factory outlook, the Leading Index popping to a 27-month high, Treasuries ignored all those typically bearish impulses and continued to rally. The offset to the bond-bearish economic news are reports the virus is spreading in Japan and Korea along with some dour economic prints in those countries. Treasury investors are betting that the raft of better-than-expected economic news will eventually give way to a slowdown over the next quarter or two as global supply chain shortages and/or continued spread of the virus present ongoing challenges. It should be noted too that the rally has some underpinnings in other factors as well. The 10-year yield has now fallen 43bps since the start of the year (1.91% to 1.48%), and has pushed through the 1.50% resistance level putting the 1.43% September low in play. There are other factors than just the virus like dollar strength, commodity weakness, falling inflation break-evens and convexity hedging by mortgage investors that points to continued Treasury strength. Those factors could well put all-time low 10– and 30-year yields in play. We explore those specifics in more detail below.
- The combination of the coronavirus impact on China in particular, and other manufacturing-based economies secondarily (see the spread to Korea, Japan and to a lesser extent Singapore), has the dollar ramping to three year highs. The effect of that will be to cheapen imports and raise the cost of exports, and also encourage continued foreign inflows to Treasuries. In summary, it’s an exceedingly disinflationary, bond-bullish environment.
- Commodity prices too have moved lower this year, particularly with the drop in oil prices on the combination of slackening global demand and the aforementioned dollar appreciation that has most dollar-based commodities, including oil, trading cheaper. As the graph shows, as oil goes so goes the commodity index, and while there’s been a slight rebound recently the fourth quarter ramp in prices has largely been erased. This is another disinflationary/bond-bullish development.
Increasing Refi’s Driving Convexity Hedgers?
The latest rally in Treasuries has ignited another factor that is likely contributing to the run and that is Treasury buying from convexity hedgers. That’s a fancy name for MBS investors that manage to a duration number, and with increasing refi’s (white line) coming on the heels of plunging mortgage rates (blue line), the subsequent increase in prepays acts to shorten portfolio durations. As a consequence, these mortgage investors buy Treasuries to add duration and positive convexity back to portfolios. This is happening now and is another factor that is not only keeping the rally alive, but aiding its push through recent range resistance of 1.50%.
|Treasury Curve||Today||Chg Last Wk.||LIBOR Rates||Today||Chg Last Wk.||FF/Prime||Rate||Swap Rates||Rate|
|3 Month||1.57%||UNCH||1 Mo LIBOR||1.64%||-0.01%||FF Target Rate||1.50%-1.75%||3 Year||1.329%|
|6 Month||1.53%||-0.02%||3 Mo LIBOR||1.70%||UNCH||Prime Rate||4.75%||5 Year||1.310%|
|2 Year||1.37%||-0.05%||6 Mo LIBOR||1.70%||-0.03%||IOER||1.60%||10 Year||1.398%|
|10 Year||1.48%||-0.10%||12 MO LIBOR||1.77%||-0.04%||SOFR||1.60%|