11/3/23 – Softer economic data squeezes Bond shorts

We had anticipated a volatile week given the barrage of economic releases and the Open Market Committee meeting but were surprised by the magnitude of the volatility.   When we closed out last week the 2-year note, and 30-year bond were both trading above 5% and sentiment was decidedly bearish.  The selloff continued into Tuesday with the 30-year touching 5.09%.  But reversed on Wednesday with the ADP employment tally coming in at 113,000 newly created jobs, below the 150,000 expected.  That started the short covering that dominated the balance of the week.  For his part, Chairman Powell’s comments at the post-FOMC press conference were about as dovish as they’ve been since they started the hiking cycle although he didn’t rule out the possibility of one more rate hike.  Despite that, the market interpreted his words as no more rate hikes.

Despite respectable unemployment insurance data, factory orders, and durable goods data, rates continued to fall into this morning’s release of employment data for October.  For the month, the economy added 150,000 jobs, down significantly from last month’s 297,000 add and below the 180,000 consensus expectation.  The unemployment rate ticked up to 3.9%, the highest in nearly two years.  The long bond has rallied nearly 40 basis points from the recent high as traders that had been anticipating a reacceleration of the economy into the fourth quarter were forced to cover.

On Wednesday, the Treasury Department announced the size of upcoming debt auction’s would focus more on Treasury Bills and reduce issuance of longer dated securities.  The action was recommended by the Treasury Borrowing committee as a way to shift issuance to maturities that are less sensitive to term premium increases.  We read the change as Treasury concern that the massive borrowing increases of the last several years are starting to weigh on the market and they’d like to shift the burden to the sector has the greatest appetite for debt, namely Treasury bills.  The excess demand in the bill market stems directly from the SEC’s de facto elimination of prime money market funds.  We can’t disagree with the strategy given the pounding the long bond has taken since mid-summer, but the bigger message is that the demand for government debt is starting to wane, and the risk is that at some point it will need to reprice with a higher term premium.

Coincidently, on Wednesday, respected hedge fund manager, Stanley Druckenmiller, said that Treasury Secretary Yellen has made the biggest blunder in the history of the Treasury Department by not extending the duration of the Treasury Debt when rates were at historic lows.  It’s hard to disagree with him when virtually every homeowner did exactly that by refinancing their mortgage.

Next week should be much less volatile as the only significant data is unemployment insurance on Thursday and University of Michigan surveys on Friday.  However, there is a cavalcade of Fed member speeches everyday next week.