A New Recipe

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This week I combine the ingredients that should be a recipe for a more sustained upward correction in U.S. rates.

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U.S. yields found a near-term bottom on August 6 (10yr .502%, 30yr 1.163%) and turned higher from there. At this past Thursday's highs in rates, the 10yr yield was up +22bps at .725% and the 30yr yield was up +28bps at 1.443% from the lows.

That was the most aggressive upside correction in yields since early June when the U.S. was emerging from lock down, the economic data was improving, issuers of corporate debt were accessing the capital markets again, and the ECB was about to announce its second round of virus support.

It is convenient to assign credit for this week's jump in yields to the loads of Treasury supply that was issued. Treasury came with a record $112bln of fixed coupon supply at the August refunding with auctions held on Tuesday ($48bln 3yr), Wednesday ($38bln 10yr), and Thursday ($26bln 30yr). To be sure, the weight of the supply did have a major impact.

It wasn't only about supply, however.

A week ago Thursday, the morning yields bottomed, I pointed out in my daily newsletter the national virus curves had been improving since the July highs.

This chart to the right from Our World in Data is of the rolling 7-day average of daily new Covid-19 cases in the U.S. While new daily cases are still far higher than at the previous peak in April, there has been marked improvement from the July high.

I also made note that the recent data was signaling the recovery is getting back on track. Over the last week, more U.S. data has supported this view:

• July ISM mfg was stronger than expected, jumping to 54.2 (from 52.6, vs 53.5 exp).
• July services ISM at 58.1, beat expectations for a decline to 55.0 (from 57.1).
• In the July employment report, non-farm payrolls surprised to the upside +1.763m (vs +1.480m exp) and the unemployment rate fell nearly 1% to 10.2% (vs 10.6% exp,11.1% last).
• The July inflation data was much stronger than expected with headline PPI up +.6% m/m (vs +.3% exp), +.5% m/m core (vs +.1% exp), -.4% y/y headline (vs -.7% exp), and +.3% y/y core (vs 0.0% exp) and headline CPI up +.6% m/m (vs +.3% exp), +.6% m/m core (vs +.2% exp), +1.0% y/y headline (vs +.7% exp), and +1.6% y/y core (vs +1.1% exp).
• The weekly claims report was better than expected with initial filings falling by -228k to +963k for the first sub-one million print since the forced lock downs were imposed in March. Continuing claims also improved more than expected, falling -604k to 15.486m. (vs 15.80m exp).
• Under the federally funded Pandemic Unemployment Assistance (PUA), continuing claims showed a sharp improvement (-2.333m) to 10,723m. The total number of people receiving unemployment benefits fell by -3.065m to 28,258m for the fewest since May.

• July retail sales missed on the headline (+1.2% vs +2.1% exp) although June was revised up to +8.4% (from +7.5%). Retail sales ex-autos was much better than expected at +1.5% (vs +1.0% exp) AND was revised higher in June (to +8.3% from +7.3%).
• Q2 non-farm productivity surged +7.3% (vs +1.5% exp) and Q2 unit labor costs soared +12.2% (vs +6.9% exp).
• Aug UMich consumer sentiment beat at 72.8 (vs 72.0 exp, 72.5 last).

Optimism is also building for a viable and accessible vaccine before the end of the year. While I still have a healthy level of skepticism that a vaccine will be approved, manufactured in mass, distributed, and administered before year-end, the scientists have a more optimistic view.

Indeed, outlined in this article from govi.org (The Vaccine Alliance), the worldwide race to develop the first vaccine is on. Just this week, Vladimir Putin claimed victory when he surprised the world by saying Russia has received approval from the Heath Ministry on a vaccine in human trials that will move into production in two weeks. Not to be one-upped, China also said it will have a vaccine in 2020. There's reason for hope.

I also pointed to the recent tightening the race to be the next U.S. President. This chart from PredictIt (via Bloomberg) shows a narrowing of the spread in the betting markets . . .

. . . and a tightening in the polls as this graphic from The Hill/Harris shows (Biden +4 vs +7 in the previous survey).

Ingredients for an Upside Correction in Rates

Two of the risks that pushed U.S. yields to the August 6 lows, the secondary outbreak in new Covid-19 cases during June and July and the slowing of the economic recovery caused by it, both improved heading into August. These positive trends have continued.

More recently, the tightening in the race for president also argued rates don't need to stay down at pandemic extremes (GOP policies are viewed more favorably for business and in the markets).

With these risks improving and the bond market facing heavy supply during the week that will grow heavier as the quarter progresses, I noted "This is a recipe for a better upside correction in U.S. rates and for a steepening on the curve."

What else?

On Wednesday, I offered this perspective. "I'm thinking there is more to this upside correction in yields. Even if we rally out of the 10yr through the 30yr, there has been a major technical breakdown in the bond market. Yields were holding at stubbornly low crisis levels all while the major equity indices continued to trade to new highs."

"Something had to give; it looks like it is the rates market that is falling on the sword, and rightfully so. We've just moved through an aggressive secondary outbreak of Covid-19 and we learned that measures that aren't too draconian can be taken to effectively bend those case, hospitalization, ICU, and death curves again."

"That's big. That allows the recovery to pause, reset, and resume."

The Mitchell Market Report, 8-12-20

The major technical breakdown referenced above can be clearly seen on the chart above.

As you can see on the chart below, yields are now above the key moving averages (MAs). The MAs are within a basis point of crossing negatively for the first time since late June. When they do (Monday), it will officially signal the near-term trend in yields is to the upside. Supporting this view is the fact that yield momentum has turned higher from oversold extremes (see lower panel below).

With the MAs set to cross, yields above them after such an emphatic technical breakout, and yield momentum oversold and moving higher, selling strength that takes yields lower is now the disciplined and optimal strategy in the U.S. bond market.

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This article is part of my LinkedIn Newsletter Series: Indicators and Insights – Perspectives on the Top Financial Market Movers with a View of What's to Come.

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This report represents the opinions of its author. It reflects market and financial information that we have obtained from third party sources; we believe it to be accurate, but we make no warranty to that effect and are not responsible for any inaccuracies in the information presented. Nothing in this report constitutes personalized investment advice to any reader or a solicitation to effect or attempt to effect transactions in securities. All investments involve risk. Past performance may not be indicative of future results. Due to various factors, including changing market conditions, the opinions set forth in this report may no longer reflect the current views of the author. The author is not an investment adviser, law firm, or accountant, and nothing in this report should be construed as investment, legal or accounting advice. Additional information is available upon request. Copyright (c) 2020. All Rights Reserved. The Mitchell Market Report,LLC