Grant's Interest Rate Observer

Is A Rally in Treasurys Imminent?

A kind word for the 10-year

Last week’s violent stock-market pullback was accompanied not by a flight to safety into government bonds, but rather the opposite. Much to the dismay of risk-parity practitioners (Grant’s, May 29, 2015), Treasury yields instead shot higher. The 10-year note’s ascent to a 2.85% yield, up from 2.41% at year-end 2017 and more than double its July 2016 low, has broken the bullish trendline which has been in force since the 1980s, as Bill Gross of Janus Henderson Investors plc noted on CNBC back on Jan. 10.

 

We avowed bond bears at Grant’s nevertheless observe that this recent lurch in yields has returned some semblance of value (on a relative basis) to the Treasury realm. A trio of sightings:

 

– Bloomberg’s Tracy Alloway noted Saturday on Twitter that the spread between investment-grade corporate bonds, as measured by the Bloomberg Barclays Investment Grade Option Adjusted Spread Index, dropped to just 85 basis points last week—close to its tightest level since 2005. Spreads tightening during a selloff is a little unusual, and could imply that Treasurys are trading cheap just as much as it could imply that corporates are trading rich.

 

– So, too, does the 10-year Treasury note’s yield premium over the German bund look robust, with the 211 basis-point spread close to a 10-year high and almost triple its average differential over the post-2008 period. While the euro has appreciated significantly against the greenback in recent months and Germany has benefited from lower inflation, the gap using real yields is still substantial. With headline CPI of 2.1% as of December, the 10-year note still produces a 75 basis-point yield. Germany, which reported a 1.6% headline CPI print for January, offers investors a negative 90 basis-point real yield.

 

 - Investor positioning is another factor that Treasury bears must keep in mind. According to the Commodity Futures Trading Commission, total speculative short positions on the 10-year-note futures ticked to a record-high 886,851 contracts as of Jan. 30, while net short positions in 10-year-note futures rose to 215,600 contracts, its highest since March of last year.

 

That March buildup was followed by a solid rally in Treasurys that took the 10-year yield to 2.2% in June from 2.6% three months prior. Could another bounce in the price of Uncle Sam’s debts be in the cards?