U.S. Bond Market Gives Notice It’s No Longer a One-Way Street

A market that has been trending in one direction for many years was dealt a rude awakening last week as traders of U.S. government debt.
Interest rates had risen to their highest levels in years in anticipation of upcoming interest-rate hikes from the Federal Reserve and the central bank starting to remove Treasury notes and bonds from its balance sheet by not replacing them when they matured. Short-dated yields led the move for the majority of the first quarter.
The tune of the market has shifted in the last few weeks, with long-dated yields leading the upswing, but a mid-week plunge in short-dated yields has traders wondering whether they are looking at a new trend or just a new bout of gains-harvesting. In tandem with the reversal, a number of large transactions in related futures contracts were executed, therefore locking in profits.
According to Tuesday’s report, consumer prices excluding food and energy rose less than expected, providing a fundamental catalyst for bettors that the Fed may end up raising rates less than currently expected since inflation is slowing, meaning short-dated yields will fall. It is unclear whether an inflation consensus is in the works, or when one might be. There won’t be much economic data next week.
Gregory Faranello, U.S. rates trading and strategy head at AmeriVet Securities, said, “the bond market is in an awkward period right now.”. “The inflation is extreme, and we are unsure what level it will decline to or how high it will be.”.
This is how it played out: The two-year note’s yield — which reacts more strongly to changes in the Fed’s policy rate than longer-dated yields — fell to 2.27 % on Thursday from 2.60% on April 6, the high for this year. The VIX ended the week at 2.45% after a sharp rebound on Thursday, when an import price gauge rose more than economists expected. U.S. markets were closed Friday.

A swoon in two-year yields raised concerns regarding the Fed’s ability to raise rates this year, even as a half-point hike at the next meeting is nearly fully priced into corresponding futures contracts.
Despite the low interest rates, New York Fed President John Williams said that was a “reasonable option” on Thursday. For the first time since 2018, the March quarter-point increase was 0.25%-0.5%. Moreover, Williams predicted that underlying inflation is about to peak. Next week, Jerome Powell will participate in a meeting of the International Monetary Fund.
In its recommendation, TD Securities predicted a decline to 2.25% in the yield on three-year Treasuries.
There is a current hypothesis that if tighter monetary policy, pandemic containment measures and the fallout from Russia’s invasion of Ukraine limit growth, the peak in interest rates may be lower and closer than previously thought. At the moment, futures markets expect a peak of just over 3% in mid-2023.
When the economy grows little and inflation exceeds target, Faranello said, it is unclear how central banks will respond.
Long-dated yields continued to rise, reaching a 2022 peak of 2.83% for the benchmark 10-year note. It collided with an upward sloping trend line that’s contained it for the last generation. Several analysts were convinced that the four-decade bull run in bonds was ending, aided by the Fed’s decision to allow its portfolio to run off.
10 Year Market Trend

Also on Thursday, the 30-year bond yield surpassed its highest level of the year — 2.93% — which meant that the yield curve steepened, reversing the powerful market trend of curve-flattening over the past year.
On April 4, a reduction in the difference between two- and 10-year yields, which peaked in 2021 near 162 basis points, fell to a low of -9.5 basis points where the two-year yields exceeded the 10-year again for the first time since 2019.
In the five-to-30-year curve, which inverted for the first time since 2006 on March 28 and reached an extreme of -15.6 basis points on April 6, the curve climbed back to 13 basis points.
Jason Pride, chief investment officer of private wealth at Glenmede, commented that a steeper, more normal-sloping curve has been healthy after recent inversions. In order to slow the economy, the Fed wants the markets to fall further, especially for credit and stocks.
In contrast to the past, curve-flattening began much earlier relative to the first hike than typically takes place, putting traders on edge about when trend reversal might begin.
According to JPMorgan Chase & Co., the recent bout of steepening was just a temporary dip in the markets. Following the move, the company’s interest-rate strategists recommended preparing for lower interest rates. Accordingly, the Fed’s balance-sheet measures are only expected to have a limited impact given pension-fund demand for long-maturity debt and expected pension-fund demand.
In the weeks ahead, bond traders can expect more competition in the market. Everything is on the line. The Treasury market had its worst quarter ever in the first quarter, and it’s off to a bad start in the second.