U.S. Bond Markets Confusing Price Action Amid Increasing Calls To Red

Many differing views make for a confusing day, which is never a great way to start the morning. 

PBoC

While many market participants remain concerned about onshore liquidity in China, today’s MLF operation has provided Chinese banks with some relief. Last month, the central bank tightened funding conditions, triggering an onshore liquidity squeeze ahead of the Chinese New Year holiday. The move also implies that the central bank is in no rush to make sharp turns in the monetary policy before the National People’s Congress in March.

The PBoC also offered CNY20 bln of 7d reverse repo. Some CNY280 bln of the instruments are due today. 

I wouldn’t take this as any sign of tightening. Indeed this is standard practice for the PBoC during the Chinese New Year holiday period: injecting short-term cash to offset Chinese New Year related cash demand and then mopping up liquidity after the holiday.

Odd Bond Market Action

Yesterday’s US bond markets price action was very odd but at the end of the day a curve that ‘bull flattened,’ hopefully sending the message that with supply behind us, rates look set to consolidate following a 20bp Bond yield ripper from last week.

In the US session, Treasuries opened weaker as US bond desks looked to the price in more compromise for the $27 bln auctions following Tuesday’s price action, leading to a sizeable selloff in 20-year. US data was decisively strong, with the and both consensus beaters. Yet the market head faked lower, only to quickly recover. 

With supply now out of the way, it feels like yields can breathe a sigh of relief, and with fewer auctions to worry about over the near term it’s a pleasant thing for risk. 

On the other hand, continues to wallow amid iShares 0-5 Year TIPS Bond ETF (NYSE:) selling in all shapes and sizes, suggesting we may not be that far off markets getting a severe case of the taper jitters. I’m not telling to flatten all a risk. It’s only a fact that one needs to prepare, just in case. But I can almost guarantee as we make hay for the weekend you will hear more calls to reduce risk given the early warning signals that the selloff is starting to weigh on risky assets. 

Gold below $1800 looks very technically driven and maybe not the death knell’s sounding although the death cross certainly triggered. But China is back?

Gold had another rough day on Wednesday, as the stronger and higher rates continue to take their toll. Unlike on Tuesday, the retracement ran into very little real money demand, and gold traded to a new low of $1770 on technical selling from algos.

Technically, it doesn’t look right. The focus has been on the Death Cross pattern, that triggered only the third time in the past seven years. Looking back at the last two times it hit, gold retraced 12.0% and 10.8% in the following weeks. The yellow metal has not closed below the 50-week moving average since 2018.

On a positive note, China is back, and traders are looking for signs of physical demand to resurface at these levels. Positioning should be so much cleaner and ETF outflows of 900k over the past nine days. Indeed, speculative longs have left the scene, but I suspect shorts are not brave enough to test the lower bound after the pushed back the timetable for tapering and US yields ripper abated somewhat.

Improving COVID-19 Trends and Robust Economic Data

Improvements in the COVID-19 pandemic situation, along with newly-released robust economic data, allow investors to turn their attention to updates on reopening timelines.

US equities were little changed again on Wednesday, the down 0.1% heading into the close. yields were down 2bps to 1.29%, with up 1.4%.

Investors continue to run the gauntlet of higher yields, less compelling valuations and month-end seasonality, but improving COVID-19 trends and robust economic data allow investors to turn their attention to updates on reopening timelines—especially from the UK and the US as cries for a quicker end to mobility restrictions grow more vocal.

The market is moving higher this morning as the rip in US rates takes a small pause, with the 10-year yield back below 1.30%; whether yesterday was a speed bump or a turning point remains to be seen. It certainly doesn’t seem to be contrarian to say US rates have room to move higher.

The market turned decidedly more defensive as similar themes continue to bubble below the surface, with the reopen and reflation trade outperforming. In contrast, investors continued to retreat from expensive tech names that have powered the market higher this year as the rates debate remains heated.

Interestingly, yields are a bit softer today after what was generally acknowledged to be a solid day for economic data in the US, which could have triggered an adverse market reaction to decreased stimulus urgency or higher yields on surging activity signs. But the FOMC minutes continue to douse fixed income fires and push back the timetable for tapering while signaling no sense of policy urgency as the minutes show a united Federal Reserve committee expecting it is likely “to take some time” to achieve the “substantial progress” goal on guidance.

And if the market wanted improved economic data, it most certainly shouldn’t be disappointed by the massive beat on US retail sales. But talk about putting fuel on the fixed income fire; if you were worried about inflation too, on top of the US January retail sales beat, US January PPI data was well ahead of expectations with the year-on-year number at +2.0%, against forecasts for +1.0%, and after +1.1%. Still, rates didn’t go flying off the fixed income handle. They sold off in a knee-jerk response, but it bounced back sharply.

While the market will have to price the higher probability of stimulus tail risks materializing that could push US bond yields high enough to cause a more intense systematic high valuation risk reduction, as long as the Fed keeps the front end anchored, that should allow equity markets to keep performing.

Still, the thorny point is trying to pick a number out of a hat that will cause maximum market discomfort as the harbinger of all stock market doom could be rapidly accelerating yields above 10-year 1.5 %. I stress ‘rapidly’ here as I think the market can handle even higher rates if the economic condition remains supportive. The long-term balancing act suggests any risk market can stay at lofty levels, provided the macro conditions remain well supported. 

Oil Markets Virtuous Circle

Even Saudi Arabia can’t stop the rally in crude oil prices after announcing its plans to ease supply cuts now that the market is back in balance. Crude oil sold off on the headline but was then drawn back higher by enormous open interest on the Mar. 21 WTI 60 strike which expired Tuesday. I don’t think the markets were overly shocked about the Saudi rollback amid the roaring recovery in global demand, good news on the COVID-19 vaccine roll-out, and the extremely healthy oil price. 

For trader concerns, the keen takeaway seems that OPEC+ is happy with crude prices at these levels over the medium term. Perhaps traders will soon put in a top to the impressive rally from sheer exhaustion alone, but certainly more likely when the pipeline and wellheads start to extract more product. 

The data pointed to another large inventory draw. Still, the build-up gasoline inventory raises a few eyebrows as the polar vortex conditions could be keeping enough folks off the road to mostly offset heating demands. Oil prices did cool slightly on this news, but nothing should be considered a rally stopper—even under normal conditions.

With oil prices trading tangentially to the US vaccination distribution curve, it’s easy to argue that the Texas storm has triggered a virtuous circle of events for the oil market and has likely taken oil prices to a level where markets were eventually heading, but just a little bit quicker than expected. 

Some reports suggest it could take as long as three to four weeks for Texas oil production to recover fully and, in that timeline, the US will inoculate 30-40 million more citizens just in time to partake in annual Spring Break road trips when there’s typically a gasoline surge. So, even when Texas production resumes, there might not be too much of a dip to be had.

Gold Markets

Gold yields to higher yields and struggles to pare losses as the dollar remains firm. Gold is unimpressed with progress on the fiscal package, but Fed minutes push back the timetable for tapering, which is supportive.

Gold investors continue to lick their wounds as not even another dovish chapter in the FOMC minutes could bandage over what could be a mortal blow to the gold markets. It’s the behavior of short-end rates, rather than the 10-year yield, that should be of most interest here to gold and currency traders. And while the market will continue to read “the highest since”, as ten-year yields add on another 50-70 bp this year, comparing the strip now to two weeks ago, Fed lift-off is still expected at the end of 2023—in line with Fed guidance. But the pace of hikes is exponentially much quicker than it was only a fortnight ago. 

Currency Markets 

The USD is exaggeratedly stronger in response to the higher US yields. Still, with risk sentiment turning green again, it should lend some discomfort to dollar bulls as the risk on-risk off is still one of the dominant directional impulses for the USD as differentials are just not high enough to thwart that USD bearish impulse. 

Also, the Fed’s rhetoric remains dovish and appears written in stone in the FOMC minutes, suggesting policymakers may let the economy run hot, which for now means less USD support.

Chinese Yuan

Markets in China opened today after the Chinese Lunar New Year holidays. Fundamentals still support the amid China’s steady economic recovery. Of late, the People’s Bank of China has consistently set the daily fix slightly weaker than market expectations. 

The PBoC and State Administration of Foreign Exchange have jointly taken steps to slow down capital inflows and encourage outflows by adjusting the so-called Macro Prudential Assessment framework to manage onshore companies’ capabilities to lend to and borrow from overseas.

Both measures haven’t been aggressive enough to stop the RMB from extending its rally, suggesting that the central bank is not necessarily uncomfortable with a stronger currency. With China’s dual circulation strategy, there’s less pressure on the currency to stay competitive against the US dollar. However, officials’ critical message in China is that the pace of appreciation needs to slow down.

Malaysian Ringgit

The  snapped its run of gains, primarily on the back of the MCO extension in KL and another state. But positively higher oil prices continued to offset higher US yield. 

The local FX market tends to react negatively to an initial mobility restriction announcement and then improve from that point on. So, the ringgit is unlikely to wander out too far along the beaten track.

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