Treasury merchants see supply-demand danger with returns close to the lows

The timing of major upcoming shifts in government bond supply and demand will determine whether the recent downtrend in yields continues or eventually reverses.

The 10-year yield fell 25 basis points in July, the largest drop in a month since the pandemic panic rocked markets in March 2020, and a fourth straight period of declines. The Federal Reserve's comment, which accompanied their most recent monetary policy decision last week, helped some observers reinforce the idea that they are in no rush to withdraw monetary support, which is adding downward pressure on yields, even if they are inflation rises.

In the week ahead, traders will turn their attention to the U.S. Treasury Department's quarterly refund announcement – which could point to the supply side of the equation – and how that will likely offset against any move by the Fed to scale back their asset purchases at some point down the road . Economic data like the upcoming monthly job report will be key to shaping the monetary outlook as always, but perusing the markets may not be as straightforward.

"The extent to which Treasuries are determined by the fundamentals is just as unknown at this point as the actual data itself," wrote BMO strategists Ian Lyngen and Ben Jeffery in a message to clients.

Treasury bond supply is expected to decline as the U.S. government eventually cuts the size of its debt auctions, and officials can provide timing guidance in the quarterly repayment announcement. If it is earlier than the market is betting, investors will be faced with a faster shrinking stack of securities, which will put more pressure on interest rates. Conversely, a more leisurely schedule could move markets in the other direction. But even if the government is considering it, there is no guarantee the Treasury Department will provide much visibility to investors beyond the quarter ahead.

On the flip side, one of the major sources of demand in the treasury market will also be changing, as the Fed is expected to move away from its $ 120 billion monthly asset purchase program at some point. A dovish tone from Chairman Jerome Powell last week helped dampen yields, but any sign that they are moving faster or that inflation trends are forcing their policies could be a catalyst for interest rates to rise again.

For Societe Generale's Subadra Rajappa, the effects of the Fed's withdrawal are likely to fuel an imbalance as the stack of bonds the market has to absorb is "quite large, especially given that they start in November and end in mid-2022" .

Most of the focus will likely be on Powell himself at the Jackson Hole conference in late August, but with that event nearly a month away, the market is likely to be guided by its own judgment for now on what economic data means and what is tapering for tapering The Treasury itself says about the supply side.

The 10-year yield ended the week at 1.22%, near its weekly low and more than half a percentage point below its highs for the year.

What can be seen

Economic calendar:
Aug 2: Markit PMI for US manufacturing; Construction expenses; ISM production Aug. 3: factory orders; Durable goods orders Aug. 4: MBA Mortgage Applications; ADP employment change; Markit US Services PMI; ISM Service Index Aug. 5: Downsizing at Challenger; Trade balance; Initial applications for unemployment benefit; Long consumer comfort 6: Payrolls outside of agriculture; Wholesale supplies; Consumer Credit Fed Calendar:
August 3: Federal Reserve Governor Michelle Bowman, August. 4: Fed Deputy Chairman Richard Clarida Aug. 5: Fed Governor Christopher Waller

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