USD Swaps: Choppy USTs; Rate sell-off stops when negative feedback loop ends

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Choppy USTs; Rate sell-off stops when negative feedback loop ends

Within a vacuum of major market-moving data and/or headlines, a choppy flow-driven trade is closing out the week for the U.S. Treasury market.  In the early afternoon trade, yields are currently mixed with the curve bending flatter into the weekend. 

The benchmark 10y UST note yield is last 0.8bps higher at 4.252% after carving out a circuitous intraday range of roughly 4.20-4.26%.  On the curve, the 2s10s spread is 1.5bps narrower at -72.4bps while the 5s30s spread is 2.7bps narrower at -6.4bps. 

Meanwhile, red SOFR futures are chalking up 2 to 5.5 tick losses while SOFR swap spreads are narrowly mixed with the wings outperforming amid paltry SOFR IRS volumes overall, if best seen a the 10y and 30y tenors.  In the backdrop, despite a modestly buoyant risk tone (Dow +0.14%, S&P +0.27%, Nasdaq +0.07%), the post-Labor Day IG new issue market has shuttered for the week after pricing a hefty $55bn (ex. SSA) since Tuesday. 

Looking ahead, strategists at BofA believe that “the path of least resistance in the US rates market is likely higher yields until there is a clear signal of negative feedback from the real economy and/or financial conditions.”   Indeed, in the bank’s view, “higher rates are the path of least resistance due to strong growth, daunting supply/demand balance, and overweight real money positioning” and “the rate selloff will only stop when there is (1) clear evidence the economy is slowing, (2) negative feedback via financial conditions tightening, or (3) cuts are fully priced out.”  

And BofA believes that “these conditions do not yet appear to be met yet.”  The bank expounds below:

”…We expect the clearest stop to the rate rise will likely come from financial conditions including increased evidence of higher default risk, earnings revision downgrades, or overseas slowdown contagion. There are early signs of some negative feedback from financial conditions into the rates market. Since Jul 31, the SPX has declined nearly 3% while 10Y rates rose 27bps. The rolling 30D correlation between 10Y yields & equities is now nearly as negative as just prior to the SVB failure & regional bank stress.

 

“…As our equity strategists have been discussing, ERP (equity risk premium) demonstrates a highly negative relationship with interest rates. So far, the impact of higher interest rates on equity valuations has largely been more than offset by ERP compressing to post-GFC lows. We likely need to see a negative growth driver generate a widening of ERP to prompt an equity market response that would coincide with flight to quality flows into the UST market.

 

“…The market is clearly reflecting some signal that the recent interest rate rise is starting to bite. If and when higher real rates begin to weigh on the growth outlook, the rate sell-off should stabilize. Recent data suggest we may be getting close. However, if financial conditions remain moderate and the growth cycle expands with inflation moderating towards 2%, it is possible that most cuts are priced out and the Fed only delivers a few cuts like they did after the 1994 or 2018 hikes. In this case, we would likely see the end of the selloff, but at levels closer to 4.75% 10y, in our view.”

SOFR swaps – 2s -10.125bps (+0.5bps), 3s -17.875bps (+0.375bps), 5s -22bps (-0.125bps), 7s -31bps (-0.375bps), 10s -29.375bps (-0.5bps), 20s -63.75bps (+0.125bps), 30s -57.25bps (unch).

New issues

• Nissan Motor Acceptance Company LLC is working on a benchmark deal via BofA, MIZ, SocGen, USB and WFS after investor calls scheduled for Monday.

   

• Australian gas supplier Santos Finance (Baa3/BBB-) plans a USD 10y through Citi, DB, Mizuho and RBC. 

   

• Slovenia is preparing a USD 10y through Barclays, BNPP, Citi, DB, GS and JPM.