The U.S. Treasury Department "Debt Wave" is coming! Global stock and bond markets face a major test

According to the Zhītōng Finance APP, on Tuesday in U.S. Eastern Time, the U.S. Department of the Treasury will begin selling up to $125 billion in U.S. Treasury bonds. The global stock and bond price rally triggered by hopes of a rate cut by the Federal Reserve this year will face its first major test since the rate cut expectations intensified. Powell's less hawkish remarks last week and weak employment data have driven up global bond prices, and this week, the U.S. Treasury will issue $125 billion in 3-year, 10-year, and 30-year U.S. Treasury bonds.

It is understood that since Federal Reserve Chairman Powell made much milder-than-expected remarks after the rate decision last week and weak non-farm data was released, global investors have been heavily buying bonds such as government bonds, corporate bonds, and stock assets. On Tuesday in U.S. Eastern Time, as part of the so-called quarterly refinancing of U.S. Treasury bonds, global bond investors will have to absorb $58 billion in 3-year U.S. Treasury bonds. Later this week, the U.S. Treasury will issue a total of $67 billion in 10-year U.S. Treasury bonds and longer-term 30-year U.S. Treasury bonds.

This U.S. Treasury bond sale will show whether investors are keen to continue buying government bonds, an almost risk-free asset, after recent sharp drops in U.S. bond yields. In the past week, under the reignition of rate cut expectations, the 2-year U.S. bond yield, as well as the "global asset pricing anchor" 10-year U.S. bond yield, has dropped by more than 20 basis points (bond yield trends are opposite to price trends), with the significant drop in the 10-year U.S. bond yield largely driving the rebound in the value of risky assets such as stocks.

The large-scale U.S. Treasury bond sale will also test the market's interest in longer-term bonds, as the slogan "higher for longer" has become ingrained in the minds of investors with the trend of term premium, prompting some investors' interest in longer-term bonds to deteriorate.

Since the beginning of this year, three consecutive months of unexpectedly strong U.S. inflation data, as well as strong employment and consumption data, have fueled the aggressive expectation in the U.S. bond market for the benchmark interest rate to remain "higher for longer," with the 10-year U.S. bond yield soaring to 4.74% at one point this year, hitting the highest level since October last year.

Not only are global bonds facing a test, but the trend of risky assets such as stocks is also facing a test.

If the $125 billion U.S. Treasury bonds of various maturities this week are not fully sold, it means that the supply of U.S. bonds exceeds the demand from global bond investors, which often stimulates the yields of various maturity U.S. Treasury bonds, especially the "global asset pricing anchor" 10-year U.S. Treasury bond yield soaring In October 2023, the "anchor of global asset pricing" briefly broke through the milestone of 5%, soaring to the highest level since 2007. The 10-year U.S. Treasury yield single-handedly disrupted the trends of major global risk assets in the second half of 2023. If the 10-year U.S. Treasury yield resumes its upward trend in the near future, the market cannot help but worry about another potential blow to stock prices, cryptocurrencies, and other risk assets.

From a theoretical perspective, the 10-year U.S. Treasury yield is equivalent to the risk-free rate indicator r in the denominator of the Discounted Cash Flow (DCF) valuation model, an important valuation model in the stock market. When other indicators (especially cash flow expectations in the numerator) have not undergone significant changes, and even in the case of expectations leaning towards a downward trend during the concentrated disclosure period of April-May U.S. stock earnings reports, if the denominator level remains high or continues to operate at historical highs, the valuation of global tech stocks, high-risk corporate bonds, and riskier emerging market currencies faces the risk of collapse.

"The yields of U.S. Treasuries of various maturities have dropped significantly in the past week, so the issuance of $125 billion in U.S. Treasuries should be a good test for the current yield levels," wrote ING Bank NV interest rate strategist Benjamin Schroeder in a report. "In the short term, the trigger to push up the risk-free rate benchmark of government bond yields may still come from the United States."

TD Securities pointed out that the 10-year U.S. Treasury yield could reach 5% or even higher levels. Prashant Newnaha, a strategist at TD Securities based in Singapore, who predicts further declines in U.S. Treasury prices, said, "Our feeling is that unless Federal Reserve officials change their stance to dovish and make the risk markets aware of it, there is still more room for selling fixed-income assets. The U.S. 10-year Treasury yield rising to 5% or even higher levels is not impossible."

As Federal Reserve Chairman Powell denied the need for further rate hikes and hinted at an immediate rate cut once inflation data is assured and confidence in inflation returning to 2% is strengthened, U.S. Treasury prices rebounded across the board. A government report released last Friday showed unexpectedly weak growth in non-farm payrolls and wages last month, adding new evidence to the recent cooling of the U.S. economy and inflation.

However, investors remain cautiously increasing their bets on the Fed's dovish policy. Interest rate swap trades linked to Fed meeting dates fully priced in a 77% probability of a 25 basis point rate cut at the November rate decision, as well as the possibility of two rate cuts in total this year, rather than close to 100%. Ahead of the recent FOMC meeting, the market also expected only one rate cut in 2024, with the latest first rate cut timing moving from December to November The rise in US Treasury bonds has spread to other bond markets. In the past week, the yield on Germany's 10-year government bonds fell by nearly 15 basis points, the UK's 10-year government bond yield fell by about 20 basis points, and Australia's 10-year government bond yield fell by over 10 basis points.

Global stock markets have also rebounded significantly recently. In the Hong Kong stock market, the decline in US bond yields has helped the Hang Seng Index rise for ten consecutive days, entering a technical bull market, making it the best-performing major global stock index in April with a gain of over 7%; the benchmark S&P 500 Index in the US has risen by nearly 5% since April 22, the UK's FTSE 100 Index has risen by nearly 6% during the same period, and the MSCI Emerging Markets Stock Index achieved its best weekly performance since July before the May Day holiday.

Investors in stocks and bonds need to closely monitor US bond issuance data and inflation data.

Therefore, whether the upward trend in global stock and bond markets can continue depends on US bond issuance data - including whether the yield at auction meets market expectations and whether the issuance size matches the actual quantity, as well as upcoming economic data - with a focus on the US inflation report for April to be released next week, which is considered the most important market driver.

Despite signs of sharp slowdown in certain areas of the US economy, overall inflation, especially core service inflation excluding housing, remains high - this reality may significantly limit the policy actions of the Federal Reserve and imply that yields on various maturity US bonds may remain within recent ranges.

Compared to relatively lower levels earlier this year, US Treasury yields remain high, which helps attract buyers seeking to lock in higher yields to continue participating in recent US bond auctions. Data compiled by State Street, a global asset management giant, shows that the allocation of fixed income assets in April increased by 0.4 percentage points to 27.9%, the largest monthly increase since March 2023, while the allocation of stocks and cash assets decreased. Statistics show that demand is focused on government bond assets.

Michael Metcalfe, Head of Macro Strategy at State Street Global Markets, said, "If US rates are indeed going to remain high and stable, investors may start to reassess their significant underweight positions in fixed income assets such as government bonds." It looks like they started doing this in April