Treasury Yields Extend Slide Amid Signs of Extreme Bearishness

(Bloomberg) — U.S. Treasury yields slid Tuesday for a third straight day, amid signs that positioning for higher yields had become extreme, setting the stage for a snap-back.

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Those signs amplified fundamental concerns about the potential impact on global growth of new Covid lockdowns in China, against the backdrop of interest-rate increases by the Federal Reserve and other central banks. Concerns were underscored by weakness in equities ahead of earnings reports from Microsoft Corp. and Google parent Alphabet Inc. after the bell. The S&P 500 declined 2.8% and closed just above this year’s low set in March.

The Treasury rally was led by the policy-sensitive two-year note, whose yield fell as much as 14 basis points to 2.49% in late U.S. trading as Alphabet shares sank. Earlier, an auction of new two-year notes drew a yield of 2.585%, the highest since January 2019 but about a basis point lower than its pre-sale level, a sign demand was stronger than anticipated.

“A lot of rate hikes are priced in and there is a big short base in the front end,” said John Brady, managing director at RJ O’Brien, a futures brokerage in Chicago. “There is a sense of fading Fed tightening expectations, and some accounts do see value in the two-year at 2.55%.” Large block trades in Treasury two-year futures initiated by buyers helped fuel the rally.

Longer-maturity yields declined less but reached the lowest levels in more than a week. The benchmark 10-year note’s yield declined as much as 9.7 basis points to 2.722%, the lowest since April 14.

Economic data led by durable goods orders and consumer confidence were mixed, but an inflation gauge later this week may carry more weight. The core deflator for March personal consumption expenditures, the Fed’s preferred inflation gauge, is expected to moderate in Friday’s report, which Brady said is supporting Treasuries.

Economists surveyed by Bloomberg expect core PCE to rise 5.3% year-over-year in March vs 5.4% in February.

Long-dated Treasuries also are poised to benefit from month-end buying by pension funds. Strategists at Wells Fargo projected in a note Tuesday that U.S. defined-benefit corporate pension funds will add $4 billion to bonds, which “could extend the recent rally in the long end over the next couple of days.”

From a technical perspective, though, the 10-year yield may have difficulty sustaining a decline below 2.72%, corresponding to a 38.2% retracement of its April increase from roughly 2.31% to 2.98%. It depends, Stifel Nicolaus & Co. strategist Chris Ahrens said in a note, on “how big the short-base is that wants to cover prior to the May 4 FOMC” meeting, the U.S. central bank’s Federal Open Market Committee.

Bearish positioning mounted last week as Fed policy makers appeared to endorse market expectations for a half-point interest-rate increase on May 4, with swap contracts referencing Fed meetings dates also pricing in half-point increases in June and July, and a total of 250 basis points of additional rate hikes this year.

A one-sided short position has been built up in Treasuries, “driven by deleveraging activity” as flattener trades were “closed out in size last week,” Citigroup strategists Edward Acton and Bill O’Donnell said in a note. The bank’s model “continues to make the case for tactical mean-reversion as the one-sided short positioning in US Treasuries is extreme,” and bearish bets against the 10-year note will be under water should the benchmark yield fall below 2.68%.

The price action extends a period of extraordinary volatility in Treasury yields. The daily range for the 10-year note’s has exceeded 15 basis points four times in April, compared with six times during the entire first quarter.

(Updates yields.)