The "massive battle" on bonds escalates because the Fed comes into play by the Treasury divide

The tide in the $ 20 trillion treasury market appears to be turning in the bulls' favor for the time being, and expectations are rising that the Federal Reserve will be boosting longer-dated debt purchases as early as next month.

The US government debt was in its best week since August after the Treasury Department demanded that the Fed return unused funds from emergency loan programs. The central bank announced late Friday that it would comply with this request. The development supported Wall Street's predictions that the Fed will announce further monetary policy measures at its meeting in mid-December.

Strategists unite to persuade the Fed to focus its $ 80 billion monthly purchases on longer-term commitments to stimulate the economy as coronavirus cases mount and talks about fiscal stimulus stall . That backdrop helps cap long-term interest rates, which affects reflation trading in bonds – namely, betting on a steeper yield curve that struggled even after positive vaccine news.

Jerome Powell, Governor of the US Federal Reserve, listens during a hearing of the Senate Banking Committee in Washington, DC, the United States, on Thursday, June 22, 2017. Leading U.S. banking regulators are sprinting to simplify the Volcker Rule, stress tests, and other restrictions on Wall Street after the Trump administration released a long list of proposals last week to pull back financial rules after the crisis. Photographer: Andrew Harrer / Bloomberg

Andrew Harrer / Bloomberg

"There's a big war on bonds," said Jack McIntyre, who helps Brandywine Global Investment Management oversee approximately $ 62 billion. "The vaccine was supposed to be selling news, but it didn't last. Market expectations of Fed action prevent bonds from being sold."

Longer runtimes were the best results of the past week. The 5 to 30 year yield curve, which reached its steepest level since 2016 on November 4, has flattened to the level last observed in September.

The flattening momentum picked up on Friday as traders braced for a week of shortened holidays and a total of nearly $ 200 billion in 2, 5, and 7-year auctions, including floating rate notes, on Monday and Tuesday crowded. In the meantime, an above-average index expansion at the end of the month could trigger the long-end to outperform by the end of November.

The 10-year benchmark returns are at 0.82% after looking like they would break the all-important 1% mark for the first time since March after the US election. And the declining net stakes in bond futures on so-called leveraged accounts have fallen from the record level in October.

JPMorgan Chase & Co. is among those predicting that the Fed will use its December 15-16 meeting to extend the maturity of its US Treasury bond purchases and create a catalyst for reducing longer-term yields. The Fed is currently buying government bonds over a range of maturities without focusing on any sector.

Andrew Hunter, an economist at Capital Economics, wrote in a note on Friday that Treasury Department's actions regarding emergency programs should not have a material impact on the economy. But he said it could still increase the likelihood of the Fed providing more stimulus, most likely by accelerating its monthly asset purchases.

Treasury Secretary Steven Mnuchin said Friday that his agency and the Fed had enough firepower to continue to support the economy. He wants to revive conversational talks with Congressional Democrats by proposing the use of unused Fed funds as part of a new aid package.

The tug-of-war on government bonds, which rose roughly 8% in 2020 according to a Bloomberg Barclays index, is likely to stretch through to year-end, even if the worsening pandemic seems to be affecting investors right now.

A barrage of option trades has emerged, betting that the 10-year yield will fall to 0.7% by the end of December. However, many companies are looking beyond short-term economic headwinds to a brighter 2021 that will drive long-term returns. Kathy Jones of Charles Schwab & Co. sees the 10 year potential to be 1.6% next year.

"People are nervous about the virus as many states have partial bans and school closings," said Elaine Kan, portfolio manager at Loomis Sayles & Co. "So returns are likely to fluctuate and the more negative headlines we get." The flatter the curve will be. "

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