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 The View

  The week that will be

 This week will likely mark the beginning of the rate cutting cycle in the Euro Area and Canada. For the ECB this would be the first cut since 2019 and after 450 bp of rate hikes in between. For the BoC, the first cut since 2020, after 475 bp of hikes.

The cut by the ECB is fully priced - therefore the market's main focus will likely be the forward looking elements of the ECB's communication. With markets pricing only 60 bp of cuts for this year, anything that seems to hint at a potentially quarterly rhythm could support the very front-end. Given our bullish bias in the 3-5y part of the curve (2y1y, 5y1y rec spds, 6m fwd 2s5s bull flattener - see European Rates Watch 20 May 24), we are more interested in any communication on terminal rates. We are, however, also not expecting to receive any clarity, despite the 100 bp gap between our economists' forecast and market pricing and c. 75 bp gap between Klaas Knot's speech and market pricing.

Softening data in Canada leaves the door open for the BoC to make the first cut to its policy rate next week, in line with our economist's expectations, though we acknowledge risk of a July start (see Canada Watch 21 May 24). We expect front-end outperformance in Canada vs US to continue as economic data diverges (see Rates CA).

For the US, next week marks an important data week before the June FOMC meeting that will mainly be scrutinized for changes to the dot plot. We think it is worth reminding ourselves that a meaningful deceleration in sequential growth in the US is required to validate the soft landing expected by our economists as well as consensus. Softness in US data therefore needs to be judged against the slowdown already embedded in expectations. Given the lack of fundamental drivers in the sell-off this week (see below and Rates US) we reiterate our view of a 4.0-4.5% trading range in 10y. Our technical strategist, Paul Ciana, showed a short-term setup pointing to a rebound in yields into June of which he views as a buying opportunity for the medium-term turn down in yields he expects to begin in the 2H24 (see Rates Technical Advantage 28 May 24).

Before we get to focus on June, we still have to navigate today's inflation prints. Tokyo CPI will have been released overnight, EA inflation this morning and US PCE this afternoon. As always, we would argue that at this stage in the cycle the emphasis should lie on momentum rather than YoY comparisons and on unrounded figures. We expect to see confirmation that on a momentum basis we are much further ahead in the disinflation process in the EA than in the US.

The week that was

Global rates increased and curves bear steepened. There was no single catalyst for the move but rather a combination of factors. Fundamentals: better consumer confidence data and recent higher inflation in UK & GE; market reaction seemed outsized vs data surprise. Positioning: asset managers have been adding to longs but CTAs remain short at the back end; asset managers may have had limited capacity to lean against the move. Supply: US auctions were weak leading to supply / demand concerns. Positioning and supply likely more important than fundamentals this week.

A notable rise in JGB rates likely exacerbated the global move. There were no signs of Japanese authorities leaning against the 10Y JGB above 1% or yen weakening.

  Rates - US

•      Lean against non-fundamental rate moves, add duration w/ 5-10y >4.6-4.65%
• Trade UST supply / demand via 30y B/E & tighter spreads, not bear steepening

Demand air pocket, lean against the wind

US & global rates increased and bear steepened on the week. The move was most pronounced early in the week, but partially reversed on Th. There was no single catalyst for the move but rather a combination of factors across fundamentals, flows / positioning, & supply. We discuss drivers below but generally see the move as overdone. We recommend clients use similar sell offs to buy on dips, esp. if 5-10yT > 4.6-4.65%

Fundamentals: US data generally exceeded expectations early in the week, largely led by better-than-expected consumer confidence & durable goods data. This was furthered by data abroad including stronger inflation in the UK, Germany, and Australia. On net, data surprised to the upside, but market reaction seems outsized vs the data misses.

Positioning & flows: Our most recent flows report showed asset manager (AM) duration positioning in futures at new longs after demonstrating appetite to buy earlier this month (see: Positioning skewed long & steep). Our indicators also show CTAs remain short in longer tenors & in steepeners. Our data suggests AMs might have had limited capacity to lean against the rate move as CTAs added to their steepeners. Abroad, sharp increases in 10Y JGB rates / yen weakness / risk of Japan bank selling may have further reduced UST demand confidence (Exhibit 4).

Supply: UST 2/5/7 auctions were soft. Each auction tailed, had weak indirect demand (indirect bidder % Z-scores of -1.2 to -1.8 over past 1y), & low bid-to-covers (Exhibit 5). The short week (3 large coupon auctions in 2 days) may have contributed. Today also sees the single largest net UST settlement in history ($155b) which may have driven larger dealer concessions to hold auction risk. Month end pension rebalancing seems to be more of an equity story than a UST story, with rebalancing flows out of equities favoring corporates in FI space (see Private pension fund rebalance update).

Taken together we believe the combination of fundamentals, positioning / flows, & soft UST auction demand likely supported the bear steepening. Recent price action suggests positioning / flows & supply dynamics were likely more impactful than fundamentals.

We believe clients should lean against non-fundamental rate moves. Rates briefly reached levels above where we last recommended clients go long the 5y point at 4.62% on May 18. We believe clients should be aiming to add outright duration exposure around similar 4.6-4.65% levels going forward. Our logic: Fed is unlikely to hike again & rates around those levels start to look asymmetrically skewed to the downside.

 Our technical strategist, Paul Ciana, agrees. Paul thinks US rates have modest upside into early June but sees rates turning in 2H24. He recommends building a long position during Treasury selloffs in anticipation of a larger 2H24 rally. Nibbling long into a selloff ahead of US NFP data may prove wise. For detail see Rate Technical Advantage.

We prefer expressing duration longs in the 5Y point vs the wings b/c belly is best representation of Fed cutting trough; 2y is more about timing & pace of Fed cuts, 10y or 30y is subject to broader supply / demand concerns.

Supply / demand risk = trade B/E or spreads, not TP

Recent bear steepening increased client questions about US fiscal trajectory, supply / demand risks, & the return of term premium. We think the best way to play for UST long end selloff is through longer-dated breakeven inflation widening (30y BE long is at 2.37, initiation = 2.28, stop =2.05, target = 2.75) & tighter long-end swap spreads.

Term premium: we do not place much stock in academic model measures of term premium (TP). TP measures are constructed using the difference between actual and modeled rate levels. We find that popular TP metrics are just linear combinations of the 2y and 10y rates (Exhibit 6). We don't necessarily need a TP model to tell us the 2s10s curve slope. Today's inflation risk and fiscal sustainability risk is very high relative to the past 30Y, yet TP metrics are near their lows b/c the curve is inverted. TP was 100-150bp higher in '97-'00 with US federal surplus and stable CPI b/c future Fed hikes expected.

Clients have recently discussed TP in the context of UST bear steepening. A large bear steepening would likely require a slow Fed response to building inflationary pressure. We think the best way to hedge against this risk is to be long 30Y breakevens. We have written about practical limits to bear steepening & still find these arguments compelling (see: How much can the curve bear steepen). A Fed reluctant to hike may limit how high long-end nominal rates can rise but should have less of a constraint on B/E widening.

Swap spreads: tighter back-end swap spreads are another good way to play for a UST supply / demand imbalance. Historically, 30Y swap spreads correlated well with the US fiscal outlook. This relationship broke down in '08 potentially due to Fed QE & slow growth amidst post GFC de-leveraging. More recently, there has been a better relationship between UST supply ex Fed holdings & 30y SOFR swap spreads (Exhibit 7). We think tighter back-end spreads are a better way to play supply / demand concerns vs bear steepening & higher TP. We expect UST curve steepening relative to the swaps curve which better immunizes against Fed pricing that impacts both curves.

Bottom line: the recent bear steepening of the UST curve appears primarily driven by positioning / flows & soft auction dynamics vs fundamental factors. We recommend leaning against non-fundamental rate rises & going long when 5-10y rates are 4.6-4.65%. For clients concerned about supply / demand dynamics, we recommend owning 30y B/E & longer-dated SOFR swap tighteners vs TP related bear steepeners.

  Rates - EU

• We expect the ECB to start cuts next week. Guidance probably won't change much: a meeting by meeting approach, with soft signal to a Sep cut, data permitting.
• Stay cautious on duration. We see 3-stages ahead and still believe the next weeks can deliver better entry levels for outright long Bund positions.

ECB: on the move, but not in a rush (for now)

Next week's 25bp ECB rate cut is almost fully priced. The focus will be on the guidance provided. We expect little change on that front. The press release is likely to emphasize data dependence and the need to proceed cautiously. Small revisions higher to near-term inflation (with unchanged medium-term) can also feed that caution. We believe there is much disagreement within the council on the inflation outlook, the landing point, the neutral rate, and the speed at which we will eventually get there. The press conference is thus likely to also indicate there is no pre-set path, with all meetings live.

At the same time, we would expect Lagarde to, once again, flag that there will be a bit more information in July to decide the next move and a lot more by September, pointing to September as the more likely date for the second cut. Finally, similar to recent comments from Lane this week or Lagarde at the last press conference, we would expect a clear distinction between the phase of "reducing the level of monetary policy restriction" and that of "normalising rates", showing they are in no rush.

As a reminder, our baseline is that the ECB will deliver one cut per quarter in 2024 (Jun, Sep, Dec) but that data (a persistent inflation undershoot to target) will eventually push them to speed up the cuts from Dec-24 (one 25bp cut per meeting until 2% in Jul-25).

Markets are pricing in the opposite path, ie almost a 50% slowdown in the pace of cuts in 2025 (from 20bp of cuts per quarter in the rest of 2024 to two 25bp cuts for the whole of 2025). In fact, in the last two weeks, the market hasn't just repriced the terminal rate higher, but it also priced in a slower pace of convergence to neutral in both basis point terms and in relative terms (Exhibit 8). The long positioning in 2025 Euribor contracts could have exacerbated this dynamic as rates sold off.

3 stages ahead

We are structurally bullish EUR rates vs market forwards for the medium/long term, as our baseline for Jun-25 Depo is over 90bp below current market pricing, and our economists see the ECB starting cuts again in 2026, towards 1% (vs market pricing of a terminal rate of 2.5%). However, as we have expressed over the past four weeks, the next couple of months could provide better entry levels for outright long positions.

Jun-Jul: potential for additional rates sell-off. 4 reasons.

There are five reasons that keep us cautious on duration near term: (1) ECB rhetoric pushing back somewhat on a July cut and flagging uncertainty around the neutral rate, (2) investor positioning that may still be close to record long duration unlike in the US where longs are far from the early 2023 records according to our FX and rates sentiment survey), (3) EZ activity data is picking up and investors start to focus on the potential for more fiscal spending. As there is no immediate negative catalyst, appetite for adding duration in core EUR rates is likely to be limited. Investors may want to see the 10y UST-Bund spread drop towards 175bp before re-engaging in the cross market trade, (4) technicals point to additional for additional sell-off (see below).

We therefore recommend: (a) to focus on conditional bullish exposures such as 3-6m fwd 2s5s bull flatteners for the near term (Jun-Aug) - see European Rates Watch, and receiver spreads for the long term, in particular those with flat/positive carry (eg 5y1y). (b) to look for RV trades with limited directionality: eg the 2s3s5s PCA weighted fly discussed three weeks ago, currently at -19.2bp. The risk is more stops in belly longs. (c) to stay away from long-end steepeners as long-end receiving can persist in the selloff, keeping the 10s30s curve flat vs 2s10s and vol, and the 20y point rich also on the curve.

Jul-Aug: Rally starts with a repricing of neutral lower, but still slow cuts

Low vol in July can support carry trades. As discussed last week, this would be most bullish the belly of the curve, especially as the market continues to price in a pattern of slowdown in the cutting cycle over 2025-26. This should indeed drive 2s5s flatter and help 5y Germany outperform vs 2y & 10y. Receiving the belly of 1y fwd 5s7s10s could then also be attractive (see last week's flies with best carry outright & vol adjusted).

Beyond the summer: we could price in the need for an acceleration in ECB cuts

Continued disinflation in EA services, a series of downside surprises in EZ inflation and a clear likelihood of a long period of inflation undershoot can help change the market dynamic and price in acceleration of ECB cuts ahead. The front-end (Z5 to Z6 / 2s) would then outperform with 2s5s and 5s10s bull steepening. We would then expect resilience (limited steepening) in 10s30s versus 2s10s, as the change in narrative accelerates the need to protect pension funds' funding ratios and insurers' solvency against lower rates.

Technicals: indications of where to buy as the bearish Bund wave nears its end

Like US 10Y yield, we view the YTD uptrend in 10Y bund yield as a correction of the 4Q23 decline. It should be near a peak in the 2.76%-3.02% area, which is the 76.4% Fibonacci retracement and 2023 peak. The 50d SMA is about to cross above the 200d SMA which may entice some CTA models to add to a short position that pushes yield higher into/in June. Perhaps to the top of the channel at +/- 2.85%. For US 10y, we recently recommended nibbling long at about 4.60%, buying 4.75% and "load the boat" at/above 4.85% (See: Rates Technical Advantage: A patient summer of buying dips 28 May 2024). Corresponding levels in bunds would be nibble at 2.76%, buy at about 2.85% and "load the boat" at/above 2.90%.

 Rates - AU

• Monthly CPI and construction work done point to sticky inflation in the housing sector.
• We like 1y1y/3y2y flatteners in Australia. The structure rolls at 10.5bps/ quarter of roll and will flatten as the market pushes out the timing of RBA cuts.
• 1y1y/3y2y has steepened alongside the US and entry levels look attractive.

Sticky inflation = no RBA cuts

Monthly CPI released this week beat expectations and showed a sequential acceleration relative to the prior month. The market is now pricing close to a 50:50 chance of a cut by May 2025 and our conviction in front-end flatteners has strengthened. We continue to recommend a 1y1y/3y2y flattener, which has 10.5bps of roll per quarter (entry 18bps, current 18bps, target 3bps, stop 25bps).

Bad news for doves

There was almost no good news for doves - services inflation remains sticky, goods inflation has started to reaccelerate and inflation would have accelerated faster without government subsidies for energy and rents (Exhibit 10).

Housing inflation is a concern

Housing inflation is particularly concerning because the supply/ demand imbalance in the housing market seems to be intensifying. The Australian Bureau of Statistics (ABS) noted the monthly rate of inflation in rents would have accelerated from 0.6% to 0.7% if not for the effect of subsidies. Our first GDP partial ahead of next week's Q1 2024 GDP print, construction work done, missed expectations, and indicated that residential construction is now declining on an annual basis.

Residential construction is particularly important because rents and other shelter-linked inflation constitutes almost a fifth of the CPI basket and the rate of inflation in this component is inconsistent with inflation stabilising between 2 and 3% (i.e. the RBA's statutory target).

Australia's population growth has been higher than the rest of the OECD for most of the past decade. During the pandemic, though, population growth fell close to zero as net migration plummeted. Since then, the annual rate of growth in the population has soared and the number of Australian residents is around the level it was if 2015-19 growth rates had been maintained (Exhibit 12). Without a coincident surge in housing construction, it is hard to see how housing-linked inflation will decelerate and construction rates are now falling (Exhibit 13).

Pay 1y1y swaps, Receive 3y2y swaps

We recommend paying 1y1y swaps and receiving 3y2y swaps. The position attracts roll of about 10.5bps. We entered the trade at 18bps with a target of 3bps and a stop of 25bps. Over the past few weeks, the curve flattened as cuts migrated further out the curve and the position peaked at 13bps.

Despite a beat on CPI and market pricing of cuts migrating further into 2025, the 2s5s (and 1y1y/3y2y) curve steepened this week, led by the US. The market is now pricing the trade at 18bps again but the case for the RBA to remain on hold for longer has accumulated much more evidence. We still see the risk of another hike as low but market pricing (~6bps of hikes by Q3) seems reasonable.

When we entered the trade, we noted the key risk is that the FOMC curve reprices meaningfully, steepening the front end of global rates curves. With 35 of cuts priced this year, the risk of spillovers from an aggressive front-end rally in US rates seems minimal.

In Australia, price action in the curve indicates the likelihood of a 'goldilocks' scenario (i.e. higher real yields, lower breakevens) is now seen as less likely but the market remains evenly divided on the relative probability of economic resilience vs slowdown (Exhibit 11).

The entry level for 1y1y/3y2y flatteners is now especially attractive and the position will carry well through the Northern Hemisphere summer months.

  Rates - JP

• BoJ balance sheet would shrink only slightly even if it cuts monthly purchases to ¥4.5tn
• Net JGB supply to jump in 2024; further upside for 10yr JGB yield given current lack of demand

Net JGB supply to rise considerably in 2024

Even if the BoJ policy board opts to reduce JGB purchases at its June Monetary Policy Meeting (MPM), we expect its balance sheet to shrink only slightly, resulting in a minimal decline in the stock effects of its holdings. However, net JGB supply is set to jump within 2024, and we see further upside for the 10yr yield from current levels around 1% given (1) the potential for the BoJ to cut 5-10yr purchases and (2) the lack of demand for these maturities.

Hawkish April MPM Summary of Opinions

The Summary of Opinions from the April MPM was generally hawkish, with some members mentioning the need for the BoJ to begin shrinking its balance sheet by reducing monthly JGB purchases. We therefore think the BoJ could vote to scale back purchases as early as the next MPM on 13-14 June (for details, see Japan Watch: BoJ Watch: Apr MPM SOP: Rising concerns over weak yen's impact on inflation 09 May 24).

How would cuts to JGB purchases affect the BoJ's BS?

As of May, the BoJ was buying around ¥5.7tn in JGBs per month, while average monthly redemptions of its holdings will be ¥5.7tn in FY24 and ¥6.3tn in FY25. Assuming other conditions remain constant, we simulated how much the BoJ's balance sheet would shrink in FY24 and FY25 if it (1) leaves purchases unchanged even after the June MPM, or reduces them to (2) ¥5.5tn per month, (3) ¥5.0tn, or (4) ¥4.5tn (Exhibit 14).

Stock effects to remain in place

As of April, the BoJ owned JGBs with a value of ¥589.7tn (53.4% of outstanding). With the outstanding JGBs set to increase by around ¥30tn in FY24, the BoJ would need to cut its JGB purchases from July onward from around ¥5.7tn at present to around ¥2.7tn if it sought to reduce its holdings to 50% of outstanding by March 2025. However, we think the BoJ's considerable JGB market presence makes a cut to ¥2.7tn in the near term unrealistic. Our simulation suggests that the stock effects of its holdings are currently depressing the 10yr yield by around 77bp. If it approves a cut in monthly purchases to ¥5.0tn from July onward at the June MPM, we estimate the stock effects as of March 2025 would weaken only slightly, to around 75bp.

Net JGB supply to jump in 2024

As noted, we expect little immediate decline in the BoJ's holdings (and consequently do not expect their stock effects to weaken appreciably), but we forecast a sharp increase in 2024 net JGB supply (JGB issuance - redemptions - net JGB purchases by the BoJ). We estimate net JGB supply of ¥35.6tn in 2024, versus ¥2.3tn in 2023 (Exhibit 15).

The BoJ's purchases the largest percentage of 3-5yr, 5-10yr, and 1-3yr issues (in that order; Exhibit 16), suggesting that its operations department would mainly reduce purchases of 10yr and shorter maturities. Given that bids in the BoJ's 23 May buying operation for 1-3yr JGBs fell short of its offer amount for the first time since it introduced monetary easing in April 2013, we think its operations department will initially reduce offers for 1-3yr issues by ¥50bn in the rinban operation scheduled for early June¹.

Expect 10yr JGB yield to rise

Even if the operations department scales back 1-3yr purchases, we would not expect yields to rise appreciably given already tight supply/demand conditions for intermediate JGBs. The JSDA's April OTC bond trading data indeed shows that regional banks aggressively bought intermediate JGBs on dip (for details, see Japan Rates Watch: JSDA April OTC Bond Trading: Diverging outlooks on BoJ policy revisions 20 May 2024). However, this data and the weak outcome of the May 10yr JGB auction imply a lack of demand for long-term issues. The BoJ operations department's reluctance to reduce purchases makes it unclear whether it would cut buying other than for 1-3yr maturities. However, we think it would also start scaling back buying of 3-5yr and 5-10yr issues if the Policy Board decides on cuts at the June MPM as we expect.

The stock effects we discuss above suggest that a jump in the 10yr JGB yield is unlikely, but we see greater scope for it to rise compared with other maturities given (1) the lack of demand and (2) the increase in supply. We expect the 10yr yield to gradually rise after the June MPM, to 1.25% at end-2024 and 1.50% at end-2025.

  Rates - CA

• The door is open for the BoC to start cutting at the upcoming June meeting
• We believe the BoC can cut more aggressively than what the market is pricing in despite concerns around how wide the Fed vs BoC policy rate spread can go

Stage is set for a BoC cut

Our economist is expecting the BoC meeting on Jun 5 to start the rate cutting cycle at a pace of 25bp per meeting until reaching a trough of 3%. A series of slowing or below expectation inflation prints as well as soft labor market prints and a slowing economy all leave the door open for the BoC to start cutting rates. However, the divergence between the US & CA policy rates is viewed as a hindrance for the BoC's ability to cut more aggressively than the Fed. For '24, the market is currently pricing in 2 cuts by the BoC vs a little over 1 cut by the Fed. This is a large deviation from our economists' expectations of 5 BoC cuts in '24 vs their expectations of 1 Fed cut (Exhibit 17).

Policy rate divergence seen as a limit to BoC cuts

The concern we hear from clients appears to be driven by how far the BoC vs Fed policy rates can widen before it causes issues for the CAD currency. Over the last 20 years, the Fed-BoC policy rate spread has maxed out at 100bps back in '05 - '07 during a time when the CAD was much stronger (Exhibit 18). A 25bp cut at the June meeting will bring the spread from 37.5 to 62.5, which is in line with the max spread from '17 to '19. However, if our economists are correct, this would bring the policy spread to 137.5bps by year-end, which is driving some push back.

BoC likely to cut more aggressively than market pricing

The BoC, like the Fed, does not try to set the dollar's exchange rate which allows it to pursue an independent monetary policy. A weaker dollar does pose a risk for the BoC's efforts to lower inflation towards their 2% target but the passthrough from lower rates can be relatively modest. Additionally, rent inflation, which is one of the stickier inflation components keeping CPI elevated, would likely not be impacted by a weaker currency. Therefore, we still believe it is in the BoC's capacity to cut rates as suitable for a weakening economy without risk of reaccelerating inflation.

BoC & Fed terminal rate expectations near cycle wides

We also focus on the estimated terminal rates for each region based on 3y1y fwd swaps which, at 62bps, is close to the historical wides for the cycle and contributes to a roughly 85bp spread between 10y CAD and US rates (Exhibit 19). We expect this gap to close with the estimated Fed terminal rate coming down as data in the US slowly softens.

Bottom line: there is a clear divergence between US and CA economic data and we expect the BoC to start cutting in June, with a risk of being pushed to July. We still believe it makes sense to be long front-end CA rates vs US given this divergence, which should also drive better performance in 2s10s steepeners in CA vs US, but we see risk of a more cautious BoC due to concerns around Fed vs BoC policy rate differential.

  Front end - US

• US funding to be impacted by debt limit starting in late '24, clients are increasingly asking
• TGA & extraordinary measures dynamics likely to see X-date in summer '25, though uncertainty elevated

Debt limit has large impact on 1Y ahead funding outlook

Clients have recently asked about the US debt limit (DL) outlook & funding impacts. Below we review DL facts & discuss implications for our USD funding outlook. Bottom line: in late '24 & 1H '25 DL will lower TGA, increase excess liquidity, & likely encourage Fed QT early end. TGA & excess liquidity impact will reverse following resolution.

Debt limit law: suspension period ends on Jan 1 '25

The Fiscal Responsibility Act (FRA) of '23 suspended the DL through Jan 1 '25. There is no US DL until Jan 2 '25; on Jan 2 '25 the new DL will bind to the level of UST debt outstanding at that time. Once the DL suspension period ends, UST will employ "extraordinary measures" (EM). Congress will need to raise / suspend the DL before UST cash & EM are exhausted; if no increase the US gov't will face technical default risk (i.e. "X-date"). For more detail on technical default or prioritization risk see: Debt limit FAQ.

UST cash & EM estimate: cash = $650b, EM = $350-500b

UST cash & EM assumptions are critical to estimate timing of US gov't X-date. UST cash levels are also very important for US funding conditions. Our thoughts on each.

UST cash balance (TGA): FRA law prohibits TGA on Jan 1 DL suspension period end from being "above normal operating balances". We interpret "normal operating balances" to be in-line with 5D of UST outflows, which have recently averaged $650-700b (Exhibit 20). A similar TGA approach was taken around the last DL suspension period end in '21; in '21 the US DoJ approved an approach where UST could "hew closely to its ordinary prudent cash-management practices" into DL suspension end. This supports the view for UST cash balance of ~$650b into Jan 1 '25 & not meaningfully lower.

Extraordinary measures: once DL suspension ends UST will employ EM. EM = accounting maneuvers that allow for limited additional debt issuance headroom. Our early EM estimate is $350b-500b (Exhibit 21, appendix). Importantly, there is likely a 1-time EM measure available on June 30 of $118.5b; if UST can make it to June 30, they can likely make it through early July. The 1-time measure explains our current large EM range.

Very early X-date projection: June or July '25

We project the X-date to bind in June or July '25 but acknowledge elevated uncertainty around timing. We assume the US election outcomes does not meaningfully impact debt limit timing. DL increases are always politically difficult votes, even with unified gov't.

Market impact: bill supply, excess liquidity, Fed QT timing

The DL impacts bill supply & excess liquidity. It will also likely drive early Fed QT end. DL will limit bill supply in late '24 & 1H '25; we project bill paydowns of $573b in 1H '25. It will also add excess liquidity via lower TGA; Mar '25 SOFR/FF should be wider (see: supply / demand risk). Fed QT also likely ended at end '24 or 1Q '25; lower TGA will mask reserve demand signals, Fed won't want to scarcity as TGA rebuilt post DL resolution

         Technicals

• Short term: US yields to bounce back into June. 2Y & 30Y double bottomed. 5Y & 10Y on breakout watch. MACD crosses favor this. Medium term: We still view 1H24 as a correction of 4Q23 that is nearing an end. Post Memorial Day, we prefer buying the dips. Macro crosswinds: USUR uptrend at two-year highs (bullish USTs) but BCOM formed a head and shoulders base (bearish USTs).

View: A patient summer of buying dips

Our base-case year ahead view remains: In 2024 the US bond market is in a cyclical bull trend within a secular bear. We called for a 1Q24 rise in yields and deemed it counter-trend. As chart patterns evolved in Q1 we saw how yields could extend upside in Q2. On April 17 (see our Rates Technical Advantage report), we thought reasonable to expect the 10Y yield to peak in the 4.70-5.02% area by the Memorial Day holiday. On April 25-26, the 10Y yield reached 4.74%. The ensuing suite of April US data left little time to get long, as a 43bp decline followed. Our thought process looking ahead to the rest of Q2 and mainly 2H24 is shifting further toward buying dips.  Technical academia suggests medium-term wave (B) up in the 10Y yield during 1H24 is more behind us than left in front and wave (C) down begins this summer/fall.

Short term: MACDs and patterns say yields bounce back

Our daily charts of US 2-, 5-, 10-, and 30Y yields show the MACD indicator crossing up in favor of yields bouncing back into June. The daily chart of 2- and 30-year yields already double bottomed to target 5.10% and 4.72%.

Medium term: 1H24 higher yields, 2H24 lower yields

Our view for a 1H24 rise in yields is nearing an end. The weekly charts of US 2-, 5-, 10- and 30-year yields all still read as if the 1H24 is a correction of the 4Q23 decline and to be long USTs into the 2H24. The April-May yield declines stopped at old breakout levels (yields supported) as the daily charts show potential for a June rebound. This means that we will probably see better levels to buy USTs in June-July than right now.

Five things the US yield charts say...

1. Upside risk for US 2Y yield. A small double bottom targets 5.05-5.10% in June. In the weekly chart, we still cannot rule out a retest of cycle highs +/- 5.25%.
2. US 10Y yield: Base case is to be long for this summer/fall. We prefer to nibble at 4.6%, buy 4.75%, and "load the boat" if above 4.85%.
3. US 10Y seasonals: Since 1963, the seasonal peak for 10Y yield is May 13-20 (behind us). When 10Y yield was up in January, the peak has been +/- August 9 (patience?).
4. US 5-, 10-, and 30Y yield weekly chart uptrends YTD are still supported by trend lines and base patterns. We may see better levels to buy in June-July than now.
5. Macro mismatch = Labor vs Inflation: The US U-rate made three higher highs and higher lows and a two-year new high to favor buying UST dips. However, the index has a head and shoulders base and golden cross signal implying strength.

 Rates Alpha trade recommendations 

 Global rates forecasts