Do Not Underestimate How Low Treasury Yields Can Fall

Via Scotiabank's Guy Haselmann,

Do not underestimate just how low Treasury Yields can fall this week.

Many global macro factors are coming to a head. Downside in Treasury prices are at minimum limited this week.   My flattening call the past few days has worked well, but while I am not sure what the curve will do the next few days, I am confident that rates will fall and possibly by a lot more.  Treasuries are a safe haven, under-owned, under-loved, with pick up in yield to other sovereigns and denominated in a safer currency.
A few bullets (not a complete list):

The Chinese Securities Depository Corporation announced it will no longer accept corporate bonds rated lower than AAA for repo transactions.  Chinese equities were weaker by 5%.   As Paul Bertrand said, this will affect more than $76 B worth of issuance. Credit spreads are widening.


Germany and France are bickering in the press.   Merkel gave a harsh interview last weekend critical of France and FM Sapin of France made comments today where he said that Germany’s criticism of France’s budget is fueling Anti-EU sentiment….


The JPM Emerging Currency Index has fallen to an all-time low.


Oil dropped 4% yesterday.   Ruble is down almost 50% this year, Nigeria Naira at all-time low, CononoPhillips said it scale back capital expenditure plans next year and spend 20% less – this is an example of oil price drops impact on the energy and shale industry.  Energy stocks and bonds have gotten killed.


Equity indices are near highs, but have negative breasth, rising VIX, and divergences with HY.  Defensive sectors have been the stars such as Health Care and Utilities while Industrials and Consumer Discretionary have lagged.


VIX was up 20% yesterday.


Greece has called a snap presidential election next week.  It could possibly and eventually lead to a dissolving of parliament which could give rise to Anti-EU momentum.  Greek 10’s are 58 basis points wider today and equity index down 11%


Italy was downgraded last week.   Many believe the ECB will do Sovereign QE and so they are playing for the convergence trade.  It is certainly binary;  EU sovereigns are likely only to diverge or converge.   Convergence has been the theme and pricing is likely too optimistic at this point.  ECB sovereign QE is not certain  until they do it (though markets have come to believe it is certain, so it is mostly probably priced in at this point).


The yen traded almost 122 Sunday night and now around 119.50 (118 lows earlier).   $ in general is off highs today.  As global events look uglier, investors play for a less hawkish fed and the dollar falls.  When things simmer down and US economic data continues to print healthy, the dollar rallies.


The BIS Quarterly report yesterday outlined several themes that I have touched on over the past several months.   Even though the BIS has sounded the alarm for several years now, they raised valid concerns in this report about the impact of the large amount of foreign borrowing by EM corporates ($2.5 trillion).

  • Corporates, particularly in many Emerging Markets, have taken advantage of easy global financial conditions to ramp up their overseas (USD) borrowing and leverage.   As the USD has risen, the liabilities of those firms rise, while their repatriated proceeds – i.e., assets denominated in local currencies – fall.  These pressure have already begun and are more than evident.  These corporate exposures are bad enough, but could easily spill into vulnerabilities for both local banks and the financial system more broadly.  It is  hard to say how aggressive the fallout will be because a good deal of the risks have ended up in the hands of yield starved investors.
  • It does not help that several domestic central banks in certain countries have been raising rates to stop capital flight over fight inflation from their sinking currencies.  Throw in weaken demand from China’s morphing growth model and softening credit bubble and a negative feedback loop is evolving.
  • Those in the worst position are those countries dependent on commodity exports, those who have a current account deficit, or those who try to peg their currency to the USD (like China).   The commodity exporters may be dumping commodities at even lower prices to secure more USD.   Structural change to the US current account deficit (lower deficit) due to the Shale Revolution is a defacto-tightening to the rest of the world.

In addition, the drop in oil has crushed the energy sector and hurt several HY issues whose proceeds were tied to Shale.   HY saw its high in June while SPX made a new high last week.


The divergence between SPX performance and EM and HY is unlikely to be sustained and is now showing signs of cracking as history suggests it would.


Fixed income managers are short duration and long credit.   These position could rebalance into this week’s refunding.  Dealers and hedge funds are short and leaning against supply, especially since the 10 year auction and sometimes the 30 year auctions have struggled in the past 6 months..   But, supply begets demand.  It is only supply NOT on a calendar that materializes in a surprise fashion that is typically negative for the market, so leaning of this refunding supply is unwise.

Again, Do not underestimate just how low Treasury Yields can fall this week.