USD Swaps: Steepening ruminations; NFP ahead
Steepening ruminations; NFP ahead
Treasuries are ending the session with yields 1.1 to 12.2bps higher, with the long end of the curve spilling higher in yield. The 10y note yield is last 4.185% or 9.5bps higher while 2s10s is last 10.5bps steeper at -70bps and 5s30s 7.4bps higher at +1.2bps. Equities ended lower (DJIA -0.19%, S&P -0.25% and Nasdaq -0.10%).
The move this week has highlighted several things, sources say. For one, the move “has been a whipsaw” as “those that had once been pulling for the steepener had all gotten stopped out and beat up as the curve only ever flattened,” one source remarked. Thus, no one was really positioned for this week's move, he judged. And in the context of the relentless flattening which progressed -80bps from May to June in 5s30s and was “a pretty good move,” has now pulled back some 35bps from the lows, he noted.
Another source felt that the week’s move has more to with some “strong hands” pushing out “weaker hands” and that the month of August it is not unusual to see a big move with liquidity challenged. It seemed like “once there was a whiff of selling, then hedge funds and WC money managers piled on,” the trader suggested. However, the source did point out that some had already been in belly to long end steepeners ahead of this move, counting on the belly to outperform as Fed eases were priced in. At this point, one source felt that the move looked “overdone” and reckoned that if non-farm payrolls come near expected, then buyers could come back into the long end.
Meanwhile, swap spreads saw a small widening move across the board amid mixed volumes. On the supply side, IG new issuance priced $2.25bn in total across 3 issuers, bringing the weekly volume to $34.6bn.
Looking at the current landscape, analysts at JP Morgan believe that “the combination of strong growth and labor markets, softening inflation, and a Fed that is likely to lean towards being patient, all point to a ‘high-for-longer’ yield regime going forward.”
In such an environment, JP Morgan expects bank demand for Treasuries “to remain weak.” Thus, it argues that “absent a clear turn in the monetary policy cycle and an imminent expectation of lower yields, banks will likely continue to avoid adding securities-based duration risk in AFS portfolios.”
As a result of this backdrop, “this makes demand from bond funds that much more important as a driver of swap spreads” as “bond fund AUM growth translates into passive demand for fixed income assets, which is especially important in longer duration sectors” such as the 10y and 30y:
- “While inflows into bond funds were strong in March, they appear to be slowing. Indeed, there is also some evidence that inflows react to trailing measures of fund performance, and given the rise in yields from mid-May levels, bond fund inflows could remain soft in coming months. Further, total assets under management at the top 20 bond funds… appears to have reached a plateau in recent months, and is no longer trending higher like it was in 1Q23.”
“This risk of a softening in UST demand from bond funds due to slowing inflows, and the already weak bank demand that appears unlikely to turn, come at a time when UST duration supply is poised to increase” as Treasury begins a series of increases to coupon auctions.
“Given this confluence of a pickup in supply, structurally weaker UST demand, as well as the closing of the typical intra-year seasonal window for spread widening in late July (which had led us to recommend tactical wideners two weeks ago), we exit tactical spread wideners and instead recommend initiating swap spread narrowing positions in the belly of the curve.”
2s -10.25bps (+0.125bps), 3s -16.5bps (+0.5bps), 5s -21.125bps (+1bps), 7s -28.375bps (+0.875bps), 10s -27.5bps (+1bps), 20s -62.875bps (+1.125bps), 30s -65.875bps (+0.75bps).
New Issues
- Public Service Electric & Gas priced a $900m 2-part ($500m 10y and $400m 30y FMBs). Leads Mizuho, Scotia, TD and WFS. A1/A. +103bps and +115bps.
- New York State Electric & Gas priced a $750m 2-part ($350m 5y and $400m 10y). Leads BNPP, MUFG (B&D), MS, Santander and Scotia. Baa1/A-/A-. +140bps and +168bps.
- PACCAR Financial priced a $600m 2-part ($300m 3y and $300m 5y). Leads MUFG, ING, SMBC, TD and USB. A1/A+. +50bps and +70bps.