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A wild week in Treasuries has investors parsing the cross-currents that may sway prices for U.S. government bonds in coming weeks, including the Federal Reserve, economic data and investor positioning.

The yield on the benchmark 10-year U.S. Treasury, which moves inversely to bond prices, stood at 1.28 per cent on Friday, after falling as low as 1.128 per cent earlier in the week, nearly 65 basis points below its 2021 high on worries over slowing growth and spreading COVID-19 infections.

Flows into the iShares 7-10 Year Treasury Bond ETF hit around US$1.2-billion in the week ending July 21, their highest in a year according to Lipper, illustrating the demand for U.S. government bonds.

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One of the key questions now hanging over markets is whether Treasury yields will continue moving toward 1 per cent – revisiting the levels they touched during the pandemic – or rebound toward 2 per cent, a level many participants expected to see by year-end.

Here are some indicators investors are watching to determine the course of the Treasury market.

TAPERING TALK

The Federal Reserve surprised many market participants with a hawkish shift at its June policy meeting, with its so-called dot-plot showing some officials moving up expectations of their first rate hikes to 2023.

With the Fed’s policy meeting concluding on July 28 and the central bank’s annual symposium at Jackson Hole scheduled for late August, investors will be watching for signs that officials are backpedalling on assurances that the current bout of inflation is transitory, a message that could rattle markets.

Investors will also be looking for signals on whether officials believe the Delta variant of COVID-19 may pressure growth, potentially delaying the unwinding of the Fed’s easy-money policies and depressing yields.

YIELD SPREADS

While Treasury yields have slid, the spread between Treasuries and high-yield bonds has remained steady. That suggests that some investors remain bullish on the economy overall, while short-term factors such as positioning and supply are driving the rally in Treasuries, said Jonathan Golub, chief U.S. equity strategist at Credit Suisse, in a report.

SHORT INTEREST

Leveraged funds – including hedge funds – have piled into bearish bets on U.S. Treasuries as part of the so-called reflation trade, which saw investors position for lower yields and buy shares of companies that could benefit from a powerful rebound in growth.

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While net speculative bets on 10-year Treasury futures flipped into bullish territory last week, those on other maturities, including 30-years, remained bearish, data from the Commodity Futures Trading Commission showed last week.

A reversal in that positioning could fuel Treasury gains and drag yields lower.

ECONOMIC DATA

While the economy continues to rebound from last year’s swoon, worries that the pace of growth is slowing contributed to the rally in Treasuries earlier this week.

Citigroup’s U.S. Economic Surprise Index, which measures the degree to which the data is beating or missing economists’ forecasts, stands at 11.6, compared with its record high of 270.8 touched in 2020.

Praveen Koropaty, U.S. interest rate strategist at Goldman Sachs, believes the Fed will want to see the employment reports from July, August and September before committing to an unwinding of its easy money policies.

At some point in November or December, “the Fed will announce a taper and I don’t think the market will freak out as it will be well telegraphed,” he said.

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BREAKEVEN INFLATION RATES

Breakeven rates – the spread in the yield between a Treasury note and a Treasury Inflation Protected Security of the same duration – are narrowing, a sign that investors are showing more faith in the Federal Reserve’s estimate that high inflation will be transitory, wrote Craig Johnson, chief market technician at Piper Sandler.

“The rout in commodity markets and pullback in reflation momentum is giving the Fed’s forecast additional credibility,” he said.

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