(Bloomberg) — Bond traders are throwing in the towel on bets for more fiscal stimulus, sending yields reeling, as pressure mounts for the Federal Reserve to fill the gap with support for the pandemic-battered economy.
While results of the U.S. election continue to roll in, the likelihood of a divided government has delivered a weighty blow to the prospects for new government spending, upending a consensus bet against Treasuries. Even the U.S.’s announcement of record quarterly debt sales couldn’t damp the biggest one-day rally since April, with a slight tilt toward shorter-dated issuance helping flatten the yield curve.
The abrupt shift in outlook raises the stakes for the Federal Reserve’s next policy decision Thursday. Chair Jerome Powell is unlikely to do anything hasty, like immediately shifting policy this week, but the current moves suggest markets are looking to him to weigh in on the outlook for further economic aid — potentially sealing the fate of so-called reflation trades and sending yields lower still.
“Markets are still in a bit of state of flux because of the uncertainty surrounding these elections,” said Glen Capelo, head of rates trading at Mischler Financial. “The Fed may get involved, but that will ultimately be a reflection of how presidential policies pan out. There’s just a lot unknown now.”
Treasuries jumped along with most other major government bonds, as expectations for a Democratic sweep fell flat, taking forecasts for a major debt-financed spending spree with them.
A premature victory claim by President Donald Trump only added momentum to the rally, burnishing the appeal of havens ahead of a possible prolonged wait for a contested result. Key states such as Pennsylvania, Michigan and Georgia are likely to take some time to report.
Now, traders are waiting for signs the Fed could intervene with more economic support if Congress does not.
Yields on the 10-year Treasury note fell as much as 14 basis points to 0.75%, the biggest slide in months. Those on the 30-year bond fell as much as 18 basis points to 1.50%, extending their decline after Trump said he would ask the Supreme Court to intervene, even as several battleground states continue to count votes.
“Depending on how messy things get, 10-year yields can drop to the 0.7%-0.75% area in the short-term,” said Eugene Leow, a fixed-income strategist in Singapore at DBS Group (OTC:) Holdings Ltd.
Rates on longer-maturity debt led Wednesday’s moves lower, a dynamic that was supported by the release of the Treasury department’s latest auction plans.
It announced that the government will lean less heavily on longer-dated issuance as it ramps up overall sale sizes to fund the budget deficit. While sale sizes for 10- and 30-year debt will rise, the pace of increase will be slower than last quarter. The three-year issue, on the other hand, climbed by the same amount as last time.
“Treasury is trying to tread lightly with a pendulum swing toward the long-end, after they had done some dramatic shifts,” said Russ Certo, managing director of rates at Brean Capital. “It’s also probably easier for them to hit the intermediate maturities at this stage.
The monthly jobs report is also coming up this Friday and that may put the spotlight once again on the economic fallout of the pandemic and lockdowns.
If the economy softens, virus cases rise and Washington fails to act on stimulus, the Fed will be in a position to do more, according to Nathan Sheets, chief economist at PGIM Inc.
“In that scenario, the Fed would likely respond by doing more as opposed to withholding stimulus, trying to leverage Washington,” he said. “I don’t think Jay Powell’s going to get into that kind of game.”
The turnaround in rates, meanwhile, has blown out of the water the record short positions in bond futures that leveraged investors had piled into in response to polls showing a likely win for Former Vice President Joe Biden, and possible majority for Democrats in both houses of Congress.
Volumes in Treasury futures — typically subdued during Asia hours — surged to around eight times normal levels as results came in, according to Bloomberg calculations.
Rates Traders Add to Big Short Bet in Advance of Crucial Week
Trump’s robust performance in key battleground states such as Florida and Ohio has driven the 10-year yield back from its highest level since mid-year. The benchmark sank back below its 200-day moving average as the vote counting progressed.
“The short Treasuries trade is really coming back to bite,” said George Boubouras, head of research at hedge fund K2 Asset Management in Melbourne.
Bonds and stocks rose in tandem, compounding recent concerns about a breakdown in the inverse correlation between the two asset classes, which could jeopardize the traditional 60/40 asset allocation strategy.
With some key states still hanging in the balance, including Pennsylvania and Michigan, markets risk still more volatility and reversals in the days and weeks to come.
The ICE (NYSE:) BofA MOVE Index, a gauge of U.S. bond volatility, climbed to the highest level since April. Still, some measures of currency volatility have slipped.
As 2016 showed, market sentiment can shift dramatically in a single day. Back then, the unexpectedly upbeat reaction to Trump’s victory left many on Wall Street red-faced. Initially, Treasuries soared on election day, while U.S. stock futures plunged and the dollar tumbled, only for markets to turnaround less than 24 hours later.
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