Buy the Dip Is Back as Bond Traders Push Fed Hike Bets Too Far

(Bloomberg) -- After last week’s fire-sale in bonds, some traders say expectations for interest-rate hikes have become too aggressive and it’s time to buy.

While swaps traders see the Federal Reserve raising rates in March 2023, some strategists say that’s too much and recommend buying short-maturity bonds to fade the move. Five-year Treasuries outperformed on Monday, while their 30-year counterparts extended declines, with yields climbing further above 2.20%. In the U.K., where money markets have completely priced out rate cuts, UBS Group AG sees rates eventually meeting “fundamental resistance.”

The rapid reflation-fueled selloff that besieged bond markets last week is showing signs of stalling as investors take advantage of better valuations and with central banks lining up to emphasize that they’re in no rush to start tightening monetary policy. Traders are due to get a sense of whether poicy makers backed up their words with actions last week, with data on European Central Bank bond-buying due later.

“Central banks as well as markets need to realize that even homeopathic tightening doses can trigger outsized market reactions,” said Christoph Rieger, head of fixed-rate strategy at Commerzbank AG. It “will be interesting to get some indications whether markets are firmly in buy-the-dip mode or whether it is the ECB.”

Short is Sweet

Over in Treasuries, shorter maturities are proving popular after last week’s rout. JPMorgan Chase & Co.’s Jay Barry recommended purchasing five-year notes in the U.S., while strategists at TD Securities doubled down on their bullish stance on the same securities on Friday.

Barclays Plc’s Anshul Pradhan told investors to buy three-year securities, while Citigroup Inc.’s Jabaz Mathai recommended the “belly of the curve,” which traditionally means maturities between three and seven years.

Their views seem to have struck a chord with investors. Five-year yields fell as much as five basis points to 0.68%, and 30-year equivalents climbing six basis points to 2.20%.

Five-year Treasuries slumped last week as traders brought forward the pricing of rate hikes, driving an exodus of positions which had previously been sheltered by rate guidance from the Federal Reserve. Yields on the securities surged 16 basis points to 0.73% in the five days through Friday, with Thursday’s move the worst performance on the yield curve since 2002.

Read more: Dizzied Bond Traders Brace for More Pain as Fed Speakers Line Up

‘Not Sustainable’

“We think these moves are not consistent with the Fed’s stance and framework, and therefore not sustainable,” Guneet Dhingra, head of U.S. interest-rate strategy at Morgan Stanley in New York, wrote about the rate-hike expectations. The Fed is likely to push back against the market pricing in rate hikes in 2023, he said.

In remarks last week, Fed Chair Jerome Powell offered a reassurance that policy would continue to be supportive and look beyond a temporary pick-up in inflation, especially from a low base. The central bank’s so-called dot plot -- which it uses to signal its outlook for the path of interest rates -- shows a majority of Fed members expect rates to be unchanged from current levels at the end of 2023.

Powell will deliver this week what are likely his final public comments before a mid-month policy meeting.

Periphery Positions

Across the Atlantic, investors are also buying back into the trades that were hardest hit during last week’s selloff. Banco Santander SA is positioning for peripheral spreads over Germany -- like Italy and Spain -- to narrow. UBS meanwhile, sees U.K. rate valuations as getting close to levels to re-enter. Last month, 10-year gilt yields rose the most since 2016.

Read more: Santander Turns Tactically Bullish Periphery: EU Rates Roundup

“While we’re not quite recommending buying the dip,” said John Wraith, head of U.K. and European rates strategy at UBS, “we are definitely getting close to attractive levels to position for a reversal.”

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