A Summer of Perfect Correlation?

It might have flown quietly under the radar, but this was an eventful week in Treasury Markets – marked by the auction results turning out to be a fairly non-event. That’s an Oxymoron for you!

But more than the week, it has been the past 3-month correlation between movements in treasury yields and equity market performance which, for me, has been the star event of the year.  

Lets do a recap. Risk assets or S&P500 (or mostly the Magnificent 7) were doing quite well up until 31st July. That when the US Treasury announced its refunding plans for Q3 and Q4 of 2023. In simple terms, the Refunding Plans are the mechanism through which the US Treasury tells the market how much it intends to borrow and what format it intends to borrow in (bills vs bonds).

I had written about this in early August highlighting the substantial increase in marketable borrowing plans of the US Treasury as well as the increase in coupon auction sizes. Link here (or go to the Posts section on my Linked in Profile): https://www.linkedin.com/posts/shashank-sawant-459a06_home-activity-7092916022877306880-uzwH?utm_source=share&utm_medium=member_desktop

In immediate response to the treasury refunding announcement, long bond yields rose higher and the S&P500 experienced an equally swift fall.

The US Treasury announced its latest borrowing plans on October 30th and November 1st.

It surprised markets by announcing a lesser than expected borrowing quantum for Q4 2023 and also increased coupon auction sizes by lesser than expected. The marketable treasuries borrowing estimate for the 4th quarter of 2023 was revised down from US$852bn to US$776bn. And coupon auction sizes for auctions in the months of November 2023 through January 2024 were also lower than expected. Specifically, auction sizes for the 3 year, 10 year and 30 year bonds to be auctioned in the month of November were lower than expected by US$2bn.

Once again in immediate response long bond yields fell sharply and the S&P500 experienced an equally swift rise back up again.

Given this backdrop, the key event to watch out for in the week of 6th November was the performance of the 3 year, 10 year and 30 year treasury auctions. And thankfully, it turned out to be relatively non-eventful. Auction performance across the 3 year and the 10 year was relatively benign, while the 30 year auctions results were quite disappointing last night. The weak auction, coupled with a hawkish speech from Jerome Powell which suggested that the Fed may not be done hiking, sent bond yields higher again and risk assets lower.

The table below summarizes the auctions results this week.

*The comparison and colour grading is against an average figure of the last 6 auctions in that tenor.

In general, demand at the longer end is likely to continue to be tepid. That will cause a lot of volatility especially in the 20 and 30 year tenors (Opportunity or Risk for the TLT ETF enthusiasts!!).

Treasury yields are always a key determinant of asset prices, especially equities. Hence, it is vital to keep a close eye on developments within the US Treasury markets. While the secondary market for US Treasuries and yield levels in the secondary market are easy to keep track of (via Bloomberg or FT), keeping track of developments in the primary market for Treasuries offers even better insights for investors.   Linking back to my old article on how to read US Treasury Auction Results https://thecreditbalance.com/us-treasury-auctions/  

Or if you want to watch a video on how US Treasury Auctions are conducted https://www.youtube.com/watch?v=XGhLmQYq2mw  

What should I watch out for next?

The next event to watch out for is the October US CPI release on Nov 14, 2023. The first point to note is that the base effect is favourable in October 2023. M-o-M CPI had increased 0.5% in October 2022.

Secondly, given this base effect and the recent drop in energy prices, it is likely that we will see a fall in headline y-o-y inflation. A drop in core inflation will probably cause long bond yields to dip further slightly and will be positive for risk assets. Yet, it is equally important to consider other factors that will have a large bearing on the markets into the year end viz. government shutdown risks, seasonal trends, tax loss harvesting and larger coupon auctions into the next 2 months. In summary, both bond and stock markets seem poised for range bound activity – which makes certain option strategies like selling strangles or covered calls the ideal trades to perform. That is if you still want to generate some income instead of heading out to the mountains, beach or the bar in the holiday season!

Happy Diwali.

Not meant to be Investment Advice. Do your own research. Happy investing!

Shashank Sawant


Leave a Comment

Your email address will not be published. Required fields are marked *