US Treasury Bonds Surge: Market Reversal Driven by Positive Carry

U.S. Treasury yields have experienced a rapid decline over the past week, while the performance of the dollar, Bitcoin, and U.S. stocks has also been unsatisfactory. Overall, the "Trump trade" is beginning to cool further. Compared to the "Trump trade" in 2017, this round of the "Trump trade" also takes "re-inflation" as its theme, and like in 2017, the overall trading has appeared relatively sluggish since the beginning of the year, until a recent rapid unwinding occurred.

The slow implementation of Trump's tariff policy, the rapid involvement in the Russia-Ukraine conflict, and the recent weakening of U.S. economic indicators seem to be the main driving factors behind the retreat of the "Trump trade." However, the market's rapid retreat is also closely related to the excessive concentration of positions.

One of the biggest surprises in the market is the rapid decline in U.S. Treasury yields. The 10-year U.S. Treasury yield has fallen from a high of about 4.8% at the beginning of the year to around 4.3%. Considering that the U.S. CPI in January rose more than expected, the decline in Treasury yields does not seem to be fully explained by economic fundamentals. From a trading perspective, one of the safest trades in the market is to buy long-term U.S. Treasuries. Although investors are concerned about rising U.S. inflation and the Federal Reserve not lowering interest rates quickly, from a trading standpoint, the 2-year Treasury yield has remained consistent with the overnight SOFR rate before this round of interest rate decline, indicating that the 2-year Treasury yield has essentially flattened with the funding rate. This suggests that investors do not have much trading direction and are merely passively holding the 2-year Treasury based on financing costs; at this time, the positive spread formed between long-term bonds and 2-year Treasuries indicates that holding long-term bonds has indeed produced a rare "positive spread," i.e., positive carry.

Although the current level of positive carry does not seem high compared to historical levels, the importance of positive carry for trading is self-evident, as it provides a very important cushion for trades. In an increasingly volatile market environment, the value of such a safety cushion will certainly become apparent at some point, and right now seems to be the moment for more patient and persistent traders to reap rewards The next question is, will the "Trump trade" further cool down? We attempt to answer this question from the perspective of the US dollar exchange rate. Recently, there has been a significant narrowing of the interest rate differential between Europe and the US. In other words, although US dollar interest rates have declined significantly, the decline in euro interest rates, represented by the 10-year German government bond, has been relatively mild. From this perspective, the market's expectations for the ECB's interest rate cuts this year have not changed much. This narrowing of the US-EU interest rate differential seems to indicate that the euro exchange rate may further rise. From this perspective, the "Trump trade" in the foreign exchange market—namely, the strengthening of the US dollar—does not seem to have reached its endpoint.

If the US dollar has not yet seen a turning point, then the decline in US dollar interest rates may also not be over. However, in any case, the unexpected decline in US dollar interest rates suggests that when the market sees a clear direction, it is often one of the moments with the lowest trading cost-effectiveness; at the same time, certain trades, such as positive carry, can often accumulate small victories into larger ones. Therefore, sometimes, what truly carries the market are these seemingly insignificant positive carries, and once such trades take shape, they can carry on even more!

Author of this article: Zhou Hao, Sun Yingchao, Source: Guotai Junan Overseas Macro Research, Original Title: "【Guotai Junan International Macro】US Treasury Bonds Surge: Market Turnaround Brought by Positive Carry"

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