3 reasons Treasuries might be in for a relief rally

And why this is good for equities

I wrote earlier this week that I’m bearish long-dated Treasuries, and I’m now about to reel back my enthusiasm for being short in this oversold environment. I am still long term bearish, but short term neutral. The thing is that I’ve come upon a few insights that make me think that Treasuries are about to see a relief rally that could last weeks to several months:

The federal tax filing and payment deadline for most of CA and other disaster-affected areas was extended to Oct 16, which means the fiscal picture looks worse right now due to lower-than-expected tax receipts, and will look better after those tax receipts come in. As the budget deficit and increased issuance are the main drivers for the increase in Treasury term premium, an influx of tax receipts in Oct would tighten the deficit and perhaps allow a slower pace of issuance after the Treasury receives them. To provide context, California paid over $450B in federal taxes in 2018 and 22019 and based on an average payment of $16,895 per taxpayer in 2022, the state would have generated $320B of federal tax revenue that year. $320B is 26% of the current $1.2T budget deficit, and 1.2% of annual GDP.

Concerns about the fiscal position of the US government and the widening of the term premium is as much about narrative as it is about supply and demand. Few people are talking about the influx of tax receipts on Oct 15, but this is a factor that could dampen the current bearish narrative.

The doom loop between the US dollar and Treasuries might be getting exhausted. As yields in long-dated Treasuries surged higher, the dollar rallied, dragging USD/CNY higher. China is actively tried to suppress the weakness of CNY by selling USD/CNY in the market, which requires them to unwind their Treasury holdings. This resulted in a doom loop where higher yields → higher USD/CNY → more FX intervention and selling of Treasuries → higher yields. The higher USD was also denting risk appetite and accelerating the decline in equities.

Over the last 24 hours, USD/CNY has pulled back in its relentless rally in the face of China’s intervention. It may be too early to call this the top in USD/CNY, but if the pair stabilizes here and relieves China’s central bank of the need to sell more Treasuries, then this doom loop could stop.