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US to test investor appetite with deluge of long-term Treasury sales



The US is set to flood the market with long-term bonds next year, raising questions over who will buy the debt and at what price.

The Treasury department plans to sharply shift its bond sales towards debt maturing well into the future as the government seeks to fund vast spending programmes.

Investors will be left to gobble up $1.8tn in Treasuries with maturities of greater than one year even after accounting for the Federal Reserve’s massive bond-buying programme, according to estimates by JPMorgan. This will mark a stark contrast to this year, when a far greater proportion of the Treasury’s issuance was in shorter-term debt.

With expectations for higher growth and inflation in 2021, strategists say the US may be forced to offer higher interest rates on these longer-dated securities to entice investors to purchase the debt.

“When we add the numbers up, we have a pretty big demand gap,” warns Jay Barry, a managing director on the interest rate strategy team at JPMorgan. “We think a modest rise in yields will be necessary to encourage demand.”

Treasuries serve as a key benchmark for other types of debt, meaning a rise in US government borrowing costs could cascade across the broader fixed-income landscape. Higher yields also represent one of the main risks for the equities market, analysts have said.

Column chart of Net issuance of long-term Treasuries excluding Fed purchases ($tn) showing US poised to flood market with debt

The deluge of long-term Treasury sales comes at a time when investors have already gravitated towards higher-yielding, riskier corners of financial markets in anticipation of a robust economic rebound next year and as the Fed continues taking actions to keep financial conditions loose.

US government bond prices have fallen, as a result, sending yields close to their highest levels in nine months. Longer-dated Treasuries have borne the brunt of the sell-off, with yields on the 10-year Treasury note climbing from below 0.7 per cent at the start of October to just under 1 per cent. 

The odds of a dramatic spike in borrowing costs is low, analysts and investors say. The Treasury has already funded the $900bn stimulus package signed into law by President Trump this week, according to Jefferies, and is currently sitting on a record cash pile of $1.5tn. Issuance of shorter-term debt, known as bills, is expected to decline next year as well, several fixed income strategists said.

But investors reckon the “supply overhang” in long-dated Treasuries — as Subadra Rajappa, head of US rates strategy at Société Générale, describes it — coupled with the spectre of resurgent growth and inflation will push Treasury prices even lower next year. Ms Rajappa forecasts 10-year yields will rise as high as 1.5 per cent.

Line chart of % of marketable Treasury debt showing Foreign holdings of US Treasuries has slid to a 20-year low

Expectations for higher yields stem in part from the Fed’s reluctance to expand its footprint in the market for US government debt.

Ahead of its most recent meeting on monetary policy, a cohort on Wall Street bankers and economists had called on the Fed to shift the bulk of its bond-buying programme to longer-dated Treasuries in order to ensure that financial conditions remain easy despite the enormous issuance slated for next year. It held off, leaving investors to mop up the additional supply. 

Foreign buyers are set to absorb some of it, despite playing a much smaller role in the market in recent years. At 35 per cent, their ownership of Treasury debt is at its lowest level in nearly 20 years, Fed data show. A chunk of the buying is likely to come from Japanese investors given that their domestic government debt holdings are guaranteed to make a loss if held to maturity, said Olivia Lima, a rates strategist at Bank of America.

Banks are also expected to follow up a record year of Treasury demand with another burst of buying. Mr Barry forecasts $200bn for 2021, with an additional $175bn coming from pension funds and insurance companies. That still leaves a $644bn shortfall, according to Mr Barry’s calculations based on overall Treasury issuance, even once other sources of demand are factored in.

Given this gap, Kathy Jones, chief fixed-income strategist at Charles Schwab, said the Treasury department will need to pay up to sell its long-dated debt. 

“The demand will be there,” she said. “It just depends on how it gets priced.”

Line chart of $tn showing Fed balance sheet booms as central bank looks to prop up economy

Two run-off elections in Georgia could further exacerbate the imbalance between Treasury supply and demand. If Democrats are able to win both races in January and clinch control of the Senate, more aggressive spending packages — and therefore heftier issuance — could be in the offing next year.

Goldman Sachs, which advocates for so-called “curve steepener” bets that profit if long-term yields rise faster than short-term ones, called the elections “the next major source of event risk for the rates market”. 

A move too far, too fast in long-dated Treasury yields that is driven more by supply and demand issues rather than the prospects of faster growth will not go unnoticed by the Fed.

The central bank may need to twist its bond buying towards longer-dated debt or even increase the scale of its bond-buying programme “if the markets start struggling to take down the supply in the first half of year”, said Blake Gwinn, head of short-term rates strategy at NatWest Markets.

That would put an end to any Treasury sell-off, added Oliver Brennan, a senior macro strategist at TS Lombard. “How the Fed decides to structure its demand is going to have the single biggest impact on the market.”

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European stocks stabilise ahead of US inflation data




European equities stabilised on Wednesday after a US central banker soothed concerns about inflation and an eventual tightening of monetary policy that had driven global stock markets lower in the previous session.

The Stoxx 600 index gained 0.4 per cent and the UK’s FTSE 100 rose 0.6 per cent. Asian bourses mostly dropped, with Japan’s Nikkei 225 and South Korea’s Kospi 200 each losing more than 1.5 per cent for the second consecutive session.

The yield on the 10-year US Treasury bond, which has dropped in price this year as traders anticipated higher inflation that erodes the returns from the fixed interest securities, added 0.01 percentage points to 1.613 per cent.

Global markets had ended Tuesday in the red as concerns mounted that US inflation data released later on Wednesday could pressure the Federal Reserve to start reducing its $120bn of monthly bond purchases that have boosted asset prices throughout the Covid-19 pandemic.

Analysts expect headline consumer prices in the US to have risen 3.6 per cent in April over the same month last year, which would be the biggest increase since 2011. Core CPI is expected to advance 2.3 per cent. Data on Tuesday also showed Chinese factory gate prices rose at their strongest level in three years last month.

Late on Tuesday, however, Fed governor Lael Brainard stepped in to urge a “patient” approach that looks through price rises as economies emerge from lockdown restrictions.

The world’s most powerful central bank has regularly repeated that it will wait for several months or more of persistent inflation before withdrawing its monetary support programmes, which have been followed by most other major global rate setters since last March. Investors are increasingly speculating about when the Fed will step on the brake pedal.

“Markets are intensely focused on inflation because if it really does accelerate into this time near year, that will force central banks into removing accommodation,” said David Stubbs, global head of market strategy at JPMorgan Private Bank.

Stubbs added that investors should look more closely at the month-by-month inflation figure instead of the comparison with April last year, which was “distorted” by pandemic effects such as the price of international oil benchmark Brent crude falling briefly below zero. Brent on Wednesday gained 0.5 per cent to $69.06 a barrel.

“If you get two or three back-to-back inflation reports that are very high and above expectations” that would show “we are later into the economic recovery cycle,” said Emiel van den Heiligenberg, head of asset allocation at Legal & General Investment Management.

He added that the pandemic had sped up deflationary forces that would moderate cost pressures over time, such as the growth of online shopping that economists believe constrains retailers’ abilities to raise prices. Widespread working from home would also encourage more parents and carers into full-time work, he said, “increasing the labour supply” and keeping a lid on wage growth.

In currency markets on Wednesday, sterling was flat against the dollar, purchasing $1.141. The euro was also steady at $1.214. The dollar index, which measures the greenback against a group of trading partners’ currencies, dipped 0.1 per cent to stay around its lowest since late February.

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Potash/grains: prices out of sync with fundamentals




The rising tide of commodity prices is lifting the ricketiest of boats. High prices for fertiliser mean that heavily indebted potash producer K+S was able to report an unusually strong first quarter on Tuesday. Some €60m has been added to the German group’s full year ebitda expectations to reach €600m. Its share price has gone back above pre-pandemic levels.

Demand for agricultural commodities has pushed prices for corn and soyabeans from decade lows to near decade highs in less than a year. Chinese grain consumption is at a record as the country rebuilds its pork herd. Meanwhile, the slowest Brazilian soyabean harvest in a decade, according to S&P Global, has led to supply disruptions. Fertiliser prices have risen sharply as a result.

But commodity traders have positioned themselves for the rally to continue for some time to come. Record speculative positions in agricultural commodities appear out of sync even with a bullish supply and demand outlook. US commodity traders have not held so much corn since at least 1994. There are $48bn worth of net speculative long positions in agricultural commodities, according to Saxo Bank.

Agricultural suppliers may continue to benefit in the short term but fundamentals for fertiliser producers suggest high product prices cannot last long. The debt overhang at K+S, almost eight times forward ebitda, has swelled in recent years after hefty capacity additions in 2017. Meanwhile, utilisation rates for potash producers are expected to fall towards 75 per cent over the next five years as new supply arrives, partly from Russia. 

Yet K+S’s debt swollen enterprise value is still nine times the most bullish analyst’s ebitda estimate, and 12 times consensus, this year. Both are a substantial premium to its North American rivals Mosaic and Nutrien, and OCI of the Netherlands, even after their own share prices have rallied.

Any further price rises in agricultural commodities will depend on the success of harvests being planted in the US and Europe. Beyond restocking there is little that supports sustained demand.

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Amazon sets records in $18.5bn bond issue




Amazon set a record in the corporate bond market on Monday, getting closer to the level of interest paid by the US government than any US company has previously managed in a fundraising. 

The ecommerce group raised $18.5bn of debt across bonds of eight different maturities, ranging from two to 40 years, according to people familiar with the deal. On its $1bn two-year bond, it paid just 0.1 percentage points more than the yield on equivalent US Treasury debt, a record according to data from Refinitiv.

The additional yield above Treasuries paid by companies, or spread, is an indication of investors’ perception of the risk of lending to a company versus the supposedly risk-free rate on US government debt.

Amazon, one of the pandemic’s runaway winners, last week posted its second consecutive quarter of $100bn-plus revenue and said its net income tripled in the first quarter from the same period a year ago, to $8.1bn.

The company had $33.8bn in cash and cash equivalents on hand at the end of March, according to a recent filing, a high for the period.

“They don’t need the cash but money is cheap,” said Monica Erickson, head of the investment-grade corporate team at DoubleLine Capital in Los Angeles.

Spreads have fallen dramatically since the Federal Reserve stepped in to shore up the corporate bond market in the face of a severe sell-off caused by the pandemic, and now average levels below those from before coronavirus struck.

That means it is a very attractive time for companies to borrow cash from investors, even if they do not have an urgent need to.

Amazon also set a record for the lowest spread on a 20-year corporate bond, 0.7 percentage points, breaking through Alphabet’s borrowing cost record from last year, according to Refinitiv data. It also matched the 0.2 percentage point spread first paid by Apple for a three-year bond in 2013 and fell just shy of the 0.47 percentage points paid by Procter & Gamble for a 10-year bond last year.

Investor orders for Amazon’s fundraising fell just short of $50bn, according to the people, in a sign of the rampant demand from investors for US corporate debt, even as rising interest rates have eroded the value of higher-quality fixed-rate bonds.

Highly rated US corporate bonds still offer interest rates above much of the rest of the world.

Amazon’s two-year bond also carried a sustainability label that has become increasingly attractive to investors. The company said the money would be used to fund projects in five areas, including renewable energy, clean transport and sustainable housing. 

It listed a number of other potential uses for the rest of the debt including buying back stock, acquisitions and capital expenditure. 

In a recent investor call, Brian Olsavsky, chief financial officer, said the company would be “investing heavily” in the “middle mile” of delivery, which includes air cargo and road haulage, on top of expanding its “last mile” network of vans and home delivery drivers.

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