On the face of it, all remains bright and beautiful with the world. Australia registered super-strong (1.6% non-annualized) Q1 GDP growth, and the Oz (and kiwi, too, naturally) registered new 17 year highs against the US dollar. Chinese equities, so wobbly of late, appear to have stabilized. Growth remains good and liquidity remains ample. All aboard the market lift; next stop: financial Nirvana! Right?
Perhaps, but Macro Man was perturbed to see in his email box today not one but two clarion calls to buy bonds. It may be a bit trite to suggest that the ultimate buying opportunity occurs when the last bull pulls in his horns, but that appears to be more or less what's happened to US bonds (or, to put it another way, the bears on the economy have had their claws clipped off.)
Goldman Sachs and Merrill Lynch have both abandoned their long-standing calls for substantial US rate cuts in the second half of this year. Now, Macro Man actually agrees with this view, and has never really had much conviction that rate cuts are/were in the offing. Yet when he finds himself suddenly in the company of Merrill's David Rosenberg (whose forecast spreadsheet for the past five years has run off the simple alogorithm that if the day ends in 'y', deep rate cuts are forecast), he finds it an uncomfotable proposition.
When one considers some of the tactical factors that are driving the market, a cheeky purchase of bonds looks even more attractive. Yesterday appears to have been the day that rising real rates started to matter for equities, as a US 10 year at 5% proved sufficient to send the S&P 500 heading lower. While 5% need not be an insurmountable hurdle forever, it does seem likely that further near-term weakness in bonds will be met with a sell-off in equities, which should in turn put a floor under bonds.
Consider also that the recent run-up in energy prices should eventually become an issue sooner or later, whether as a hit to consumer confidence or via a more real impact on disposable income (and therefore, discretionary spending.) Moreover, ancillary market indicators that have been highly correlated bonds appear to be turning. Short bonds and short USD/BRL have been the same trade (at least directionally) for the last few months; the BRL appears to have turned, at least temporarily, and the little overlay below would suggest that TYU7 should be in the mid 106's rather than the high 105's.
Technically, meanwhile, Treasuries are as oversold (on a daily chart) as they've been in nearly four years. Not since the mid-2003 deflation scare/convexity squeeze was unwound has the RSI been this low. A guarantee of a reversal? Of course not. But it certainly raises the probability that a (at least temporary) rally occurs.
Macro Man will therefore kill two birds with one stone. He will sell out his 100-contract long TYM7 at 105-27, and replace it with a 300 contract long TYU7 at 105-24. The combination of technical resistance, oversold momentum, the apparent sensitivity of risk assets to higher rates, and the capitulation of Messrs. Hatzius and Rosenberg makes the risk-reward of the trade rather compelling. Macro Man will reassess the position at 105.
Perhaps, but Macro Man was perturbed to see in his email box today not one but two clarion calls to buy bonds. It may be a bit trite to suggest that the ultimate buying opportunity occurs when the last bull pulls in his horns, but that appears to be more or less what's happened to US bonds (or, to put it another way, the bears on the economy have had their claws clipped off.)
Goldman Sachs and Merrill Lynch have both abandoned their long-standing calls for substantial US rate cuts in the second half of this year. Now, Macro Man actually agrees with this view, and has never really had much conviction that rate cuts are/were in the offing. Yet when he finds himself suddenly in the company of Merrill's David Rosenberg (whose forecast spreadsheet for the past five years has run off the simple alogorithm that if the day ends in 'y', deep rate cuts are forecast), he finds it an uncomfotable proposition.
When one considers some of the tactical factors that are driving the market, a cheeky purchase of bonds looks even more attractive. Yesterday appears to have been the day that rising real rates started to matter for equities, as a US 10 year at 5% proved sufficient to send the S&P 500 heading lower. While 5% need not be an insurmountable hurdle forever, it does seem likely that further near-term weakness in bonds will be met with a sell-off in equities, which should in turn put a floor under bonds.
Consider also that the recent run-up in energy prices should eventually become an issue sooner or later, whether as a hit to consumer confidence or via a more real impact on disposable income (and therefore, discretionary spending.) Moreover, ancillary market indicators that have been highly correlated bonds appear to be turning. Short bonds and short USD/BRL have been the same trade (at least directionally) for the last few months; the BRL appears to have turned, at least temporarily, and the little overlay below would suggest that TYU7 should be in the mid 106's rather than the high 105's.
Technically, meanwhile, Treasuries are as oversold (on a daily chart) as they've been in nearly four years. Not since the mid-2003 deflation scare/convexity squeeze was unwound has the RSI been this low. A guarantee of a reversal? Of course not. But it certainly raises the probability that a (at least temporary) rally occurs.
Macro Man will therefore kill two birds with one stone. He will sell out his 100-contract long TYM7 at 105-27, and replace it with a 300 contract long TYU7 at 105-24. The combination of technical resistance, oversold momentum, the apparent sensitivity of risk assets to higher rates, and the capitulation of Messrs. Hatzius and Rosenberg makes the risk-reward of the trade rather compelling. Macro Man will reassess the position at 105.
9 comments
Click here for commentsYou cast the line, but didn't get any fish, so here's one:
ReplyA 1-in-60 year cyclone (using backward-looking probability), "Gonu" hits the Omani coast. This could be a secular result of global warming (like the secular flood of global excess liquidty) and so we should recalibrate accordingly, or it just might a roughly 1-in-60 year event, which simply should serve as a reminder that improbable events do improbably occur, sometimes improbably more frequently.
I reckon we're secularly looking at the backside of the bond bull, and,longs stay long at their financial peril. The real rate of interest remains absurdly low...even more absurdly given the bias of imbalances and the ostrich approach of one and all who are so charged, to confronting them.
Yeah, I'm not sure what to make of Rosenberg's reversal. He's been the best contrary indicator on the FFR the last few years.
ReplyI wouldn't dispute that the secular bond bull is probably over. The secular trend of disinflation, such a tailwind for bonds over the last twenty years, has to some degree run its course, courtesy of trending commodity prices and rising unit labour costs in the world's manufacturing centers. On the margin, the sovereign wealth fund phenomenon is likely to raise bond yields back towards most convention measures of equilibrium.
ReplyThat having been said, the combination of oversold conditions and a massive resistance level off er a nice technical set up. Potential pension fund rebalancing could lend a temporary bid to fixed income. And the performance of risky assets this week suggests that for the time being, a 5% 'risk free' rate is a nice alternative to so-called riskier propositions. If I can capture a 1/3 to 1/2 retracement of the sell-off, I'll be more than satisfied. Thereafter, breakevens for me, please!
Macro Man,
ReplyI doubt that the sovereign wealth funds will diminish the impact of reserve accumulation on bond yields we have seen in recent years (they are just going to prevent it from becoming bigger). The point is that even if sovereign wealth funds start plugging in say 300bn a year into "non-bonds", this will basically just compensate for the acceleration in reserve accumulation we have observed in recent months - and which in my opinion is unlikely to go away any time soon. Brad - if you happen to read this - you are the ultimate specialist on reserve accumulation, so what's your take?
If the secular bond bull is over, what might that mean for the secular (perhaps slightly younger) inversion tendency? Is the continuation of a central bank/pension fund duration induced inversion propensity really consistent with what follows the end?
ReplyAre you all preparing sympathy cards for Bill Gross, or have they gone out already?
A single Fed tightening (or its heightened threat) would probably do enough additional damage to bonds, additionally tightening overall conditions, to end this particular Fed cycle. Are you a touch early on bond longs, or close enough to the tipping point?
The recent action in bonds doesn't correlate so well with the recent action in central bank reserve accumulation.
ReplyWhy should it in future?
Hey MM, I understand that this is a hypotethical portfolio here, but shouldnt you have switched from long TYM7 into TYU7 few days earlier? Or, since it is for more of an academical purpose, you simply ignore the possibility of getting a delivery notice by some happy short?
ReplyIn any case I would frankly prefer not trying to catch a falling knife at this point and would rather wait for either break of 5.01% or some signs of reversal before committing capital. Then again your long TYU7 could be viewed as sort of a hedge on your beta portfolio, I guess.
Bureaucrat, I think the bet is that there will be less Treasury buying moving forwards than there was in the past. Japan, hegemonic in 2004, is a non player now. China will presumably buy many fewer UST than they have in the recent past. No one really knows until the SWF are up and running, but it seems likely the market's taking a bet that it will have an impact.
ReplyAnonymous, I still reckon the secular (ALM-driven) flattening trend will be there, but there is an embedded optionality to it- it's less notable at higher yields/stock prices than at lower yields/stock prices.
Bitr, you are spot on- see today's post. I see the technical set up of bonds at the moment as representing a nice hedge for long risky assets
Can you elaborate a bit on your embedded optionality comment?
ReplyAre you talking about mortgage hedging effects for e.g. or something quite different?