Bond Traders Close Out Chaotic Year With Key 1% Level in Sight

Treasury traders are buzzing about 1% yields again, with all eyes on whether a massive slate of auctions next week and two key U.S. Senate runoff elections in early January could get them there.

Rates on 10-year notes got as high as 0.971% on Wednesday after investors shifted out of bonds as Brexit negotiations looked headed for resolution, something thatdid indeed arrive on Christmas Eve. And major catalysts ahead — a trio of U.S. auctions totaling a record $176 billion amid low liquidity in a holiday-shortened week, plus the Jan. 5 vote in Georgia– could further diminish the appeal of Treasuries, increasing rates.

The widely watched 10-year yield has largely trended higher this month, but has failed to break through the 1% level last seen early in the pandemic. Democrats winning both Senate seats — and therefore control of Congress — could cause this rates barrier to fail, since the party appears more willing to unleash fiscalstimulus that gets the U.S. economy on solid footing.

The elections’ outcome “could increase movement in that direction, but 1% is a big point of resistance,” said Tom Martin, a senior portfolio manager at Atlanta-based asset manager and investment adviser Globalt Investments. Still, “Georgia is the next big news item to watch.”

There’s plenty of reasons why the 10-year rate, a benchmark for long-term borrowing costs and weather vane for investor sentiment, might miss the mark once again. One is that the Federal Reserve is keeping policy rates near zero for a prolonged period, while reserving theoption to hold down long-term rates if needed. Another is that the still-raging coronavirus is casting doubt on the ability of the U.S. and global economies to return to normal anytime soon.

Over the past week, the Treasury optionsmarket has seen increased activity for the time period covering early 2021, which captures the Georgia runoffs in whichvoting is already underway. Higher levels ofimplied volatility in the market reflect the view that a Democratic win of both races, which would give the party full control of Congress plus the White House, would put more aggressive fiscal stimulus on the radar — and raise the risk of a sharp selloff in the long end of the bond market.

Meanwhile, aggressive contrarianbets have emerged, leaning against a Democratic sweep that produces a rout. Those wagers stand to pay out if there’s just a small rise in the 10-year rate, capped at around 10 basis points from the current level of 0.92%. That may still be enough to put the yield over 1%, though just barely.

Those options expire toward the end of January and into mid-February, so the coming week’s auctions could also impact those positions. That should give bond traders a lot to ponder on their return from the Christmas holiday.

A key level to watch for the 10-year rate is around 0.973%, according to William O’Donnell, a Citigroup Inc. rates strategist. “There’s been a ‘barrier of demand’ there in the recent past and the question is, ‘will it emerge again during holiday-like dealing conditions?’”

What to Watch

  • Macro highlights of the holiday-shortened week ahead include weekly jobless claims and pending home sales. The Treasury market will shut early Thursday and close Friday for New Year’s Day.
  • Economic calendar:
    • Dec. 28: Dallas Fed manufacturing index
    • Dec. 29: S&P CoreLogic housing data
    • Dec. 30: Wholesale and retail inventories; advance goods trade balance; MNI Chicago PMI; pending home sales
    • Dec. 31: Weekly jobless claims; Bloomberg consumer comfort
    • Nothing scheduled
    • Dec. 28: 13-, 26-week bills; $58 billion of 2-year notes; $59 billion of 5-year notes
    • Dec. 29: 52-week bills; 42-, 119-day CMBs; $59 billion of 7-year notes
    • Dec. 31: 4-, 8-week bills

    — With assistance by Stephen Spratt

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