Treasurys' pause from selloff spurs faith in bond recovery
The selloff in Treasurys has taken a breather this week after the market's worst run of losses in three years, shoring up confidence that there's more room for a recovery in bonds globally.
U.S. benchmark yields traded little changed at 1.62% on Wednesday and have dropped around 10 basis points since Monday's open, putting them on course to snap a run of seven weekly increases. That's thanks to a combination of suspected buying from Asia, short covering and fresh option bets on calmer times ahead.
The rally has been mirrored elsewhere, with New Zealand seeing its biggest bond rally in a year and Europe's safest debt climbing this week as fresh lockdowns across the continent are expected to weigh on the economic recovery. German bonds were on course for their longest run of gains since December.
The bond market's reprieve "is likely to have legs," according to Royal Bank of Canada strategists led by Peter Schaffrik, who recommend investors add further tactical longs. "The medical evidence regarding the efficacy of various vaccines vis-a-vis the new strains, and the spread of the new variants, is likely to have a significant bearing on the direction of markets going forward," they wrote.
Positions in 10-year Treasury futures dropped the most in almost a month after Tuesday's rally. A slump in open interest by almost 79,000 contracts -- the equivalent of around $7.5 billion in 10-year notes -- points to investors closing out positions following a surge in new shorts late last week.
Gains in Treasurys may get momentum from the potential return of Japanese investors, who drove more than $34 billion in foreign bond outflows in the last two weeks of February. Japan's new fiscal year starts in April, so bond bulls will be on the lookout for new purchases.
The relative calm in Treasurys aided a bond rally in Asia, and reverberated across to Europe, where yields pulled back in core and periphery markets alike. German 10-year yields fell to a five-week low of -0.37%, putting focus on -0.40% as the next key level, according to Michael Leister, head of rates strategy at Commerzbank.
The price action marked a sharp contrast from last week, when benchmark yields surged to their highest level in more than a year and a gauge of longer-maturity bonds entered a bear market. Volatility had also been climbing amid a repricing of rates due to massive fiscal stimulus and vaccine rollouts.
But the fact that 10-year and 30-year yields have retreated from thresholds of1.75% and 2.50%, respectively -- the highest closing levels this year -- has encouraged some volatility sellers into the market.
A large trade on Tuesday saw a sale of so-called straddles in 10-year notes -- a combination of a put and a call with the same strike and expiry -- that expire on May 21. The investor raked in more than $24 million in premiums, with the bet paying off if yields stay within a 24 basis point range either side of Wednesday's level of 1.60%.
One final source of short-term demand for Treasurys could come from quarter-end flows. Strategists at Bank of America estimated rebalancing out of equities into bonds may result in $41 billion of Treasury purchases, according to a recent note.