Opinions

US bond markets were already adapting to the Fed’s mew communication style, which resulted in higher term premium/steeper curve before the last week’s buyback announcement. The supply glut from corporate bonds will make it worse in Sep. Sep corporate bond volumes historically speaking would be 50% above Aug and >75% higher in 10yr equivalent duration. So, when Treasury Secretary Bessent surprised markets last week by announcing a significant expansion of the US Treasury's buyback program for longer-dated Treasury securities, it was widely interpreted as an effort to relieve pressure at the long end of the curve after a sustained increase in Treasury yields. The Treasury at least doubled the maximum size of buybacks in the 10-20 year and 20–30-year sectors, implying roughly $64bn of additional annual purchases and an effective reduction in long-duration supply equal to about 15% of annual 20- and 30-year issuance. Long end yields initially fell but then ended the week where it was pre buyback announcement. We interpret that pattern as suggesting that investors remain focused on the broader forces influencing long-term rates, including the fiscal outlook, competition for long-duration capital from AI-related corporate issuance, and the increasingly price-sensitive nature of the Treasury investor base. The Treasury may be able to influence duration supply at the margin, but the market's reaction suggests that investors continue to view these structural factors as the dominant drivers of term premia and long-term borrowing costs. Purely from a treasury market liquidity perspective, the buybacks were not needed. Current off-the-runs long end USTs are priced relatively efficiently relative to a fitted curve of uniform liquidity and does not indicate any dysfunction. Similarly, the liquidity preference we can discern from comparing the asset swap spreads of near off-the-runs (the fourth off-the-run in a given sector) versus on-the-runs shows no major dislocations by this measure. Given this backdrop, we believe Treasury is uncomfortable with the rise in long-term yields, as it runs against the Secretary’s stated goal. Also the rise in long-end JGB yields YTD has had a meaningful impact on the slope of the long end of the curve. In fact the latest Treasury International Capital (TIC) flows data show that net buying of U.S. Treasury notes and bonds by foreign private-sector investors ‌fell to $16.6 billion in June, the lowest level since January. The slump in private foreign bond purchases is running in parallel with continued net selling by the official sector, whose net sales hit nearly $10 billion in June. Data on foreign-owned Treasuries held at the New York Federal Reserve suggest an uptick in Treasury sales is occurring as custody holdings are at a 14-year low of $2.6 trillion. Analysts have lowered their outlook for total foreign purchases of Treasuries this year to $450 billion from $500 billion. Given that net inflows from abroad in the first half of the year have totalled only $178 billion, there is some downside risk even to that forecast. Bessent understands most of the move in long-end yields is unrelated to the shift in Fed expectations. He has time & again commented that they do not want prices to adjust (yields to rise) to attract demand. By attempting to hold the price of longer-duration securities from falling, this leaves the Dollar as the remaining release valve to encourage foreign inflows to finance the US’s current account. After a series of supply setbacks and spending surprises, it is sensible for the market to price some discomfort with policy settings that are far below what some Taylor rule specifications would imply via a weaker currency as it implies a high bar for the data to push for a different policy approach. The fact that US continues to run a 6% budget deficit in an economy near full employment speaks for itself. To conclude, current Trump administration does not like higher long yields hence Bessent had to draw a line somewhere. But the cost of this decision will be borne by Dollar which has been seen in last week’s bull run of Gold & Bitcoin. The dollar debasement is truly back and has miles to go in months ahead.

JGBs (+0.13y) are in a refunding month and they are projected to have the largest duration extension this June. EGBs (+0.05y) are estimated to have an overall extension, and this should be most supportive of Italian BTPs (+0.013y) on a weighted duration basis, on a sovereign basis Belgium OLOs (+0.33y) are the largest extension from of the major issuers. UKTs (-0.02y) are expected to see a duration contraction, and USTs (+0.06y) see a duration increase. For USTs, this is a non-refunding month with an extension +0.06y, roughly in-line with its June average over the past three years +0.06y, and below its 12-month average +0.07y. The estimated quarterly rebalance towards bonds for US (+$81.3bn) and EU (+€113.4bn) is the largest in 10 years for both, UKTs (+£4.4bn) are just below their quarterly average. On a monthly basis, the rebalance for the US (-$6.1bn) and UK (-£0.4bn) meaning its towards equities from bonds. The EU (+€33.5bn) sees a positive flow towards EGBs.

Yesterday’s NFP report released is important because it tells us that (1) the US economy and labour markets remain firm and (2) the FX market is finally paying attention to US economic performance. We have a USD-positive medium-term view, and the positive overall USD response does not surprise us. In yesterday’s May NFP report, total employment rose 172k, which, along with upward revisions, sent the three-month average to 188k—the best in just over three years. To give a context, the neutral rate for NFP is considered 50k currently. The unemployment rate ebbed just 4bp with the rounded rate holding steady at 4.3%. NFP tell us two facts: 1. The straightforward cyclical story – the US economy and labour market look firm 2. The market reaction to the NFP data. Asset markets (especially the FX market) are beginning to pay attention to economic data, setting aside the last 15 months’ concerns about tariffs, Greenland, oil, Iran, etc. This is reflected in the rise in US real interest rates to their highest levels since June 2025, and the 0.7% increase in the BBDXY after the NFP release. The only way one can counter the rate hike rationale is through the fact that the current pace of unit labour cost inflation in the nonfarm business and nonfinancial corporate sectors is very unthreatening. Markets are now pricing in a full 25bps hike from the FOMC by end-2026, and almost two hikes by mid-2027. So, the question we ask ourselves is: Can the next Fed action be a hike. We tend to think the market has over-responded to the hawkish side recently, after over-estimating how dovish year-end Fed policy would be earlier this year. Incoming Chair Warsh is likely to bring a more powerful dovish voice to the FOMC to replace outgoing Governor Miran, and Warsh is likely to have some allies on the Board and among some regional bank presidents, even as others (not all of whom are voters this year) have turned more hawkish. We expect it will be a more gradual process to reach consensus on the FOMC to hike rates, although we continue to see some chance it could occur by year-end. The jury is still out.

With Iran conflict dragging on more than two months, US bond markets are now stuck in a tight range. 10yr UST is hovering in the range of 4.30-4.4 and rate cuts or rate hike expectations are hovering around 0 by end CY26. Crude oil continues to drive the near-term intraday moves for various assets, and the pullback in the oil price this week has contributed to the recent widening in swap spreads and the decline in implied rates vol. 10y swap spread has widened by as much as 4bps over a 1wk rolling window, which represents one of the sharpest outperformances in Treasuries relative to swaps in recent years. We believe Fed being stuck in a brittle job environment and higher core PCE, rate cuts are out of window. But rate hikes too are distant as job environment is too shaky to be considered solid. Hence markets might be stuck around pricing in +/-10 bps of cuts or hikes by end CY26. Hence carry strategies and received vol positions make more sense than any duration exposure. 1yr-1yr US SOFR is currently at 3.72 where we like to receive half risk and another half risk at 3.90. Stop loss to this view is 4% and profit target is 3.5%. We also like to receive 2*10 US SOFR steepeners around current levels of 22 for an eventual profit target of 40 with stop loss around 14 levels. Next week we also have the Treasury refunding auctions with the 10y new issue scheduled on the same day after CPI. In recent years, there has been a notable tendency of the 10y refunding auctions to perform more poorly in comparison to the reopenings. Given that the foreign takedown for the 10y auction has been trending lower since peaking in January, we are mildly cautious that the upcoming 10y refunding could face some headwinds. On Tuesday’s CPI itself, we see core CPI inflation as likely accelerating to 0.29% m-o-m in April from 0.20%, largely due to technical factors associated with rent-related components. Our forecast translates into a y-o-y change of 2.8% up from 2.6% in the previous month. It is worth noting that NSA headline CPI has generally come in below the fixings market-implied levels since the start of 2025. Even last month after the oil spike due to the Middle East conflict, actual NSA headline CPI came in below the extraordinarily high market expectation. Currently the CPI fixings market is implying 0.78% MoM headline. On the short end, repo markets this week continued to show signs that liquidity in the system is plentiful. We think the recent move lower in repo has been a product of negative T-bill supply in March and April, as well as continued (albeit slower) reserve management purchases (RMPs). We think the next catalyst for a move higher in SOFR could come in July as Treasury warned that they will be increasing T-bill sizes “across the curve” once more, and that the TGA balance could reach $1tn towards the end of the month.

Post the Iran event, DM rates have dramtically repriced. In the four weeks since the bombing began in Iran, 10-year US treasury yields have climbed 48bp, from 3.94% to 4.42%. The 10yr UK gilts have climbed up by 75 bps and the 10yr German Bund yields have climbed up by 45 bps. In UK pre-Iran event rate cut pricing of 50 bps in REMCY26 has now changed to almost 3 hikes of 25 bps each in REMCY26. Similarly in EU, status quo for REMCY26 pre-Iran event has changed now to 3 hikes of 25 bps each in REMCY26. The current violent repricing seems to be a result of concentrated received positioning in a market priced for cuts and the scars of underestimating the 2022 inflation shock. Compared to other asset classes such as equities/fx, rates IVs have shot through the roof. The big question in those assets is whether we see a deeper and broader drawdown because the energy disruption from the Strait of Hormuz is longer-lasting and the market moves to worrying about severe growth downside. That would put more outright pressure on equities and EM, may provide some relief to the rates complex, and boost the Dollar further as it cuts against the prevailing trend of more globally diversified allocations. For 10yr UST yield fair value, we use the “golden rule” of French Nobel laureate Maurice Allais. The basic idea is that over the medium to long term, nominal GDP growth is a decent proxy for return on invested capital. Therefore, in any economy bond yields should tend to converge with the structural growth rate of nominal GDP. For US the 7 year moving average of annual nominal GDP growth is 5.9% against current 10yr UST level of 4.45%. But does that mean the 10 yr UST yields are too low? It depends upon how inflation actually shapes up in next 1-2 years. If inflation cools back to Fed's 2% target, then the fair value of 4.4% is justified. But if inflation were not to cool and remain elevated then an upward march in long end yields is assured. The last time these two scenarios—diverged as much as today was in the early 1970s. For several years, the bond market couldn’t make up its mind which scenario was right. But following the Yom Kippur War and the Arab oil embargo of October 1973, the bond market concluded the first scenario—higher inflation—was correct. But the story flips on the short end. Market pricing of many front ends now looks quite asymmetric across several scenarios—we think the hike risk priced in the US, and multiple hikes priced in Europe will prove too hawkish. From a fundamental standpoint, this repricing may be reflecting some scar tissue from the inflationary episode of 2022. And G10 central bankers’ focus on indirect and second-round effects and the risk of un-anchoring inflation expectations have clear echoes of that period. And if it were a growth shock as we expect it to be soon, the rates hikes currently being priced in might need to moderate. To summarise, while the long end rates have higher probability to remain elevated due to inflation expectations as well as probable fiscal measures needed to support growth, the short end rates in DM look attractive at current levels to receive for fading out the current rate hikes being priced. Hence, 2*10 curve steepeners as well as 1yr1yr rates look attractive to receive at these levels.

We see CY2026 as an year where thought the dated UST supply will reduce, the net duration supply will increase in USTs. This will lead to curve steepening. We expect the 2-30 spread to increase to 165 bps from the current 125 bps. This is happening because Treasury strategy is shifting toward T-bills, with net note/bond issuance falling about 25% y/y amid higher redemptions and renewed Fed purchases. We expect net issuance of notes/bonds to investors to fall to $1.2trn, from $1.7trn last year, with net T-bill issuance rising from $350bn to $700bn. On the investment grade issuance side, we expect 1.6 TN USD of gross issuance & .67 TN USD of net issuance. The increase in net supply is largely a non-financial story, and the biggest upside risk is AI hyperscaler capex. In the High yield space, we can expect .35 TN USD of gross supply. In the Leverage loan space, we can expect .5 TN USD of gross supply. To summarise, We see more of curve steepening due to net higher duration supply as well as elevated net IG supply. This implies pressure on yields to rise specially if future macro data does not support further rate cuts. We don’t expect any rate cut till May when Fed Chair Powell term ends. We still expect 2 cuts of 25 bps each in June & Sep. We have been bearish on 10yr UST since 9th Nov as below recommendation: https://macro-spectrum.com/trade-recommendation/sell-10yr-ust At the time of reco, the 10yr UST yield was at 4.09 and we are targeting 4.30 levels. On Friday it closed at 4.22%.