Fixed income: beginning of the trend or beginning of the end?

If you feel like much of your bond market commentary has come from Auric Goldfinger recently, you're not alone.  The drumbeat of apparent reasons to shy away from duration seems to grow stronger by the day.   Consider that in the G4:

* The UK delivered stronger than expected growth in Q3 even as politicians openly criticize easy Bank of England policy settings.

* The hints are falling thick and fast that the BOJ is de-emphasizing the quantitative aspect of its policy, or at least the Y80 trillion purchase size aspect of it.   Anchoring 10y yields at zero appears to be the new object of focus, and if back end yields were to rise somewhat disproportionately, well them's just the breaks, right?

* In the US, this "high-pressure" nonsense seems to be taken as a code word for "not changing the modus operandi if/when inflation reaches and breaches the target."  Well, if the Fed is hinting that they'll continue to move at a glacial pace even when all of their policy targets are met, it's not hard to see why the curve would steepen on that, is it?

* In Europe, Draghi has of course pushed back on press reports suggesting that the ECB will taper before long; indeed, if anything the subsequent stories have tilted the other way.  However, there is this quaint notion of supply and demand, and with Austria issuing a 70 year bond at just 1.5% it's not hard to get the idea that Eurozone fixed income investors may be getting that heavy feeling in the pits of their stomachs that immediately precedes a Wile E. Coyote moment.   Certainly the Austrian bonds did their best Wile E. cliff-diving impression yesterday...

Though the graceful swan dive of the 50 year BTP may be even more impressive.

In the more liquid space, an interesting pattern has developed in Bund futures over the past month or so.   Down days have tended to come on heavy volume, while up days have generally seen considerably less trading.   That's ladies and gentlemen, is what a liquidation phase looks like.

So there's narrative and there's price action.   What's not to love about the fixed income bear set up?  Well, the market history of the last several years for a start.  Back in the good old days TM  the natural response to this sort of set-up would be to give the bond market a good kicking, because it paid to be a little greedy and to play for the big money.  When you saw a chart like this one in ERM7/ERM9, it would just scream "big time reversal" and you'd look to nail a move to 50 on the spread.

Alas, hunting for big game has been a dangerous exercise in the post-crisis era, where five minute macro is a way of life rather than an excuse for  a cheeky intraday bet.  Indeed, in trading a discretionary portfolio it is important not just to get the direction of the market right, but the nature of the market.   Are we in trending or mean reverting mode?   Is realized volatility going to rise or fall?  These are the types of questions that are vital in formulating an optimal sizing and risk management strategy.

In real life, of course, we can only hazard (educated guesses) at these issues.  However, even if we know the shape of the distribution, human nature apparently rebels against optimal bet sizing, at least according to this interesting paper kindly forwarded by a reader. 

So the question is, knowing what we know, is it appropriate to press or at least retain fixed income shorts, because (or in spite) of how sexy the charts look?  Alas, Macro Man finds himself skeptical.   Yesterday's durable goods report was generally poor, though at least the bit that gets plugged into GDP was solid.   However, despite this and the better than expected trade figures on Wednesday, the GDPNow forecast only went up to 2.1%, below the consensus forecast of 2.5%.

What makes Macro Man particularly wary is the apparently broad-based school of thought that this week's data "make a 3% handle possible" for GDP.  Well of course it's possible, but is it likely?   The Atlanta Fed apparently doesn't think so.   Yet anchoring is a well-known behavioural characteristic of markets, and just saying "3%" is possible makes markets more likely to shade their implicit forecasts higher than would otherwise be the case.

Given that global rates have been beaten like a rented mule this week, it doesn't require a particularly vivid imagination to see how a disappointing GDP figure could engender yet another nasty short squeeze in fixed income.  Macro Man is therefore placing his bets on the nature of the market by taking some of them off the table.    Short G4 rates have been a fantastic trade over the last few weeks, and while it's certainly possible that this is still the beginning, it seems more likely that it's closer to some sort of interim end.  Ringing the register therefore seems advisable.   

And if your author is wrong, and GDP is a barn-stormer and yields gap higher yet again?   Well, there will be a problem, as his position won't be big enough.   But that one is easier to remedy than the opposite problem- being too big at an extreme and getting caught offside come the reversal.  As nice as it would be to think that this is a big-game market, until proven otherwise the default assumption has to be that the next reversal is only ever a few days away.