Why bond traders are staying on sidelines...for now

Why bond traders are staying on sidelines...for now

There is a sentiment of depression and cautiousness hovering over the fixed income market this week as many traders take to the sidelines, waiting for situations with global equities and commodity markets to play out, strategists say.

Bond traders are operating cautiously as the market moves closer toward what many "characterize as an unnecessary [ Federal Reserve ] interest rate hike at this point," said Ian Lyngen, senior rates strategist at CRT Capital Group.

"I think the combination of data and the looming jobs report really has the market sidelined, which is why we're not seeing a great deal of response in price terms to the series of developments that we've seen," Lyngen said.

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Treasury yields barely budged Thursday after the release of multiple U.S. economic reports, including higher-than-expected initial jobless claims, which traders assumed would push yields a lot lower ahead of Friday's nonfarms payrolls report.

There was also the Institute for Supply Management's nonmanufacturing report, which wasn't as bad as economists expected as well as some relatively dovish comments from the European Central Bank's Mario Draghi , who moved to increase the institution's national cap on bond buying to 33 percent, from 25 percent.

"There's a reluctance to step in front of any significant trend. I think that given some of the low-liquidity concerns that people in the bond market have, when they start to see significant moves they sort of have a tendency to run in this sort of environment because no one wants to step in front of them," Lyngen said.

External factors, including currency volatility and headwinds in global equities and commodity markets, have been a driving force behind prices and have pushed the Treasury market into a reactive mode, according to fixed income strategists.

If the market can find a significant floor in oil and make some progress with commodities in general that could be constructive to the market, Lyngen said, adding that people are keeping an eye on what's going on overseas.

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"No one has any insight to what the central bank in China is going to do, so people are reluctant to take significant positions based on that, but that's what's driving things at this moment," Lyngen said.

Trading was relatively calm in Asia on Thursday, as compared to previous sessions, with mainland share markets in China closed until Monday due to festivities marking the 70th anniversary of the end of World War II.

Lyngen said the closure of the Chinese market will give investors "an opportunity to turn back to the U.S. fundamentals" and that the nonfarm payrolls report will set the market up, in terms of expectations, for the Sept. 16-17 Federal Open Market Committee meeting.

A strong report could undermine some of the expectations that the Fed will hold off on its first interest rate hike in more than nine years.

Despite the uncertainty surrounding global markets, the U.S. labor situation continues to improve and many economists believe the underpinning for the domestic economy, and ultimately for U.S. markets, remains intact.

The country has added 211,000 jobs per month on average so far in 2015, well above what is needed to keep up with growth in the labor force, and thus labor market slack continues to decline, according to PNC. Employment growth, PNC said, will continue at a similar pace through the rest of this year and into 2016.

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However, global currency market turmoil and falling commodity prices have dogged U.S. equities and left traders frustrated and fatigued when trying to guess the next movements in Treasurys, Lyngen said.

Prices have been subdued in the past few sessions, but the short end of the yield curve-most closely linked to monetary policy forecasts-has flattened by about 0.3 percentage point since the end of June, while the long end has remained relatively calm, said Karissa McDonough, chief fixed income strategist at People's United Wealth Management.

"That tells me that there's real concern out the curve about growth even while the Fed is messaging its intent to tighten," McDonough said.

"It's a conundrum ... I don't know if [the Fed] feels that it has to tighten because it needs to have something available in case there is a shock and it needs to cut rates again. But tightening just to cut rates again doesn't make any sense."

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In general, investors seem to be exiting equities and riskier parts of the bond market and buying Treasurys or going to cash, McDonough said. "I could never call what rates are going to do, so if you're really concerned about everything then cash is appropriate," she said.

People's United Wealth Management, which manages $5.5 billion in assets, forecasts rates to rise across the Treasury yield curve, although not in a parallel fashion.

CRT said it expects the Fed to hike at least once this year, which it thinks is for the most part fully priced into the short end of the yield curve at this point, and it sees the two-year note (U.S.: US2Y) yield ending the year at about 0.75 percent.

The outlook for the benchmark 10-year Treasury (U.S.: US10Y) yield is less clear, but CRT doesn't see the initial rate increase as a particularly bearish event for long-dated yields. It forecasts that the 10-year yield will end the year somewhere between 1.75 and 2.35 percent.



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