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.
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checkmate
admin
October 28, 2016 at 7:29 AM ×

In essence you're backing mean reversion not trend change per se. I feel you (is that hip).
Having emptied the portfolio of bonds earlier this summer I have had that rare opportunity to feel like a hero. I did this week sneak back in and buy back some short maturity corp bonds that appear to have been thrown out with the general rush to inflation be damned mentality of recent weeks. Guess I also think we have reached overshoot on the message.

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Anonymous
admin
October 28, 2016 at 10:59 AM ×

Bringing out one of those statistics: According to twitter Amazon and Google account for 65% of S&P500 market cap gains since 2014

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October 28, 2016 at 12:58 PM ×

and absolutely stunning that the stock market holds up, rock-solid, despite new, and more fierce, bouts of taper tantrum...\

http://crackerjackfinance.com/2016/10/complacent-market-fraught-with-risk/

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checkmate
admin
October 28, 2016 at 1:52 PM ×

I hear what you are saying ,but unfortunately it is equally true that people get repeatedly shaken out of good long term positions because of their fears of what might happen rather than what is happening. This is of course promulgated by a media that rejoices in creating 'noise'. That being the stuff which adds absolutely no objective analytical value whatsoever.
So, as usual we are back to the issue of separating real concerns from the perpetual wall of worry that all markets have to climb. Now I am personally going to enrich that person who thinks they have the inarguable answer to that dilemma. Don't rush.

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wcw
admin
October 28, 2016 at 2:19 PM ×

@MM, thanks for that betting paper.

In re GDP etc, the headline was 2.9, probably neither disappointing enough for a big reversal or strong enough for continued bond selling. We'll see what market bettors think soon.

In re all of the Fed's policy targets, I keep looking for core inflation over 2% and I keep not finding it. What's met that target? Yoy core PCE is 1.7, trimmed mean PCE is 1.7. Core sticky CPI >2 since early 2015, but that's shelter costs from underbuilding, not inflation. The ADS business conditions index isn't exactly breaking out, either.

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Anonymous
admin
October 28, 2016 at 3:01 PM ×

BBG: Japan’s Consumer Prices Keep Falling, Household Spending Slips. Japan’s consumer prices fell for a seventh straight month and household spending slumped in September

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Mr. T
admin
October 28, 2016 at 3:20 PM ×

Every gambler knows
That the secret to survivin'
Is knowin' what to throw away
And knowin' what to keep


You can pry my long end shorts from my cold dead hands.

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Anonymous
admin
October 28, 2016 at 3:25 PM ×

Lowest Q3 revs & EPS for $XOM as far back as Bloomberg has data & now a 19% hit to proved reserves

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Anonymous
admin
October 28, 2016 at 3:29 PM ×

Most dangerous item for bulls on my a/h board is a red $AMGN on good #'s. If it can't hold the $IBB together...Down $9 now - MUY NO BUENO - may end up being biggest headwind for the entire market in the near term

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Anonymous
admin
October 28, 2016 at 3:38 PM ×

Q3 GDP print was a *beat*.

In current world of backwards, this should speed up any form of equity selloff as longer end of the curve rips.

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Anonymous
admin
October 28, 2016 at 3:39 PM ×

Offshore yuan very close now to falling below 6.8 to the dollar for the first time (in forever.....)

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hawkeye
admin
October 28, 2016 at 3:51 PM ×

Fun chart-fest on Bloomberg (from yesterday, so maybe everyone's seen it already). Ignore the clickbait headline, there are quite a few interesting charts and ideas within:

http://www.bloomberg.com/news/articles/2016-10-27/these-are-the-charts-that-scare-wall-street

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Anonymous
admin
October 28, 2016 at 3:52 PM ×

Feeding the US FSA (free stuff army)...

"We also got the Employment Cost Index today - soft print (private wages/salaries +0.5% vs +0.6% exp). Check out gov't benefits though."


https://twitter.com/bespokeinvest/status/791982378692456448

Guaranteed bread and circuses after off shoring it's industrial base.

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Leftback
admin
October 28, 2016 at 7:14 PM ×

More Clinton email issues, this market is currently almost completely un-tradable.

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Nico G
admin
October 28, 2016 at 7:29 PM ×

yes it is i am making ten handles a day on spoos just scalping

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Anonymous
admin
October 28, 2016 at 10:32 PM ×

It's those damn ruskies again:

https://twitter.com/OnMessageForHer/status/792093163288563714

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abee crombie
admin
October 29, 2016 at 4:18 AM ×

Macro man, don't jump off the trend short bonds so fast. We've only just begun, I say hit up an anti risk parity trade. Short bonds and short stock market. Offset by some long eu reits and eu financials. I think eu rates gonna go up more from here, pushing U.S. rates higher. Fed won't blink until equity markets shit their pants. If I'm wrong then what is the scenario, more of last year? Rush into low vol and quality... Nah the market is giving a different story, it's already buying cyclicals. So pair it up with long the hated financials. Indeed eu financials have strong momentum now. But I honestly think that's a nice fade as soon as s&p breaks lower. ...so far only hard evidence I can support equity weakness is with under performance of Russell, but I think the overall s&p is topped out. Chart looks crappy. If wrong stop out at new highs, not a huge risk.

Once s&p breaks every risk asset will follow and more importantly so will pmi and confidence numbers. Get ready.

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checkmate
admin
October 29, 2016 at 6:45 AM ×

"Once s&p breaks every risk asset will follow and more importantly so will pmi and confidence numbers. Get ready."
Top down and is certainly the high probability outcome based upon historical market behaviour underpinned by abrupt changes in liquidity high leverage levels.

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Anonymous
admin
October 29, 2016 at 5:10 PM ×

For those checking in on the weekend, I don't think this is too far off topic. Here are some stories of the college children who have run up 1.5 trillion in debt as mentioned by MM. I am sure no one here believes that these children will pay their debt:

http://legalinsurrection.com/2016/10/selective-outrage-week-in-higher-education/

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abee crombie
admin
October 29, 2016 at 5:36 PM ×

Just to follow up on my previous comment. Im not wedded to a perma bear trade. It just looks like a nice set up. 1yr forward eps for most of the world is rising at a nice clip which os usually a good sign. Em outperforming ( banks, energy, materials, tech ) so there are some positive signs. Hell even eu and japan catching a bid. In high yield market, its the bbb selling off most, not the ccc of last year.But i think lets rember where we are in the cycle ( late stage) and how strong the system can weather a shock. There is so many algos and bs in equity markets today you dont need much to cause a big selloff. And if we break the 200day on spoos, chart becomes very ugly. Throw in trump winning or refusing to lose and some china story (look at bitcoin a nice proxy for china outflow) and boom confidence swings 180.

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abee crombie
admin
October 29, 2016 at 5:36 PM ×

Just to follow up on my previous comment. Im not wedded to a perma bear trade. It just looks like a nice set up. 1yr forward eps for most of the world is rising at a nice clip which os usually a good sign. Em outperforming ( banks, energy, materials, tech ) so there are some positive signs. Hell even eu and japan catching a bid. In high yield market, its the bbb selling off most, not the ccc of last year.But i think lets rember where we are in the cycle ( late stage) and how strong the system can weather a shock. There is so many algos and bs in equity markets today you dont need much to cause a big selloff. And if we break the 200day on spoos, chart becomes very ugly. Throw in trump winning or refusing to lose and some china story (look at bitcoin a nice proxy for china outflow) and boom confidence swings 180.

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Anonymous
admin
October 29, 2016 at 10:57 PM ×

Nico G said: "i am making ten handles a day on spoos just scalping"

Hahaha thanks for the laugh Nico G. It's incredible how you make millions shorting each market top with amazing (hindsight) precision, and managing to exit all losing positions with zero loss. You should teach MM and the others here how to do it - they'd all be billionaires by Christmas!

Funniest thing is your making 2600 spoos points/year with your standard 150 lot size, and yet you can't afford MM's proposed subscription of a few dollars. Gotta love the internet!!!!

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Anonymous
admin
October 30, 2016 at 12:46 AM ×

Macroeconomic Advisers predicts US equities will fall by at least 8% if Trump wins. This would wipe out all the 2016 gains in the S&P 500 (which is currently up more than 5%) and would also have a knock-on effect on major indices all over the world. Similarly, the dollar would likely rise as investors engage in a flight to quality and safe havens. Investors would shun US assets such as stocks and bonds. This would be a repeat of the situation seen in the financial crisis, where the dollar index peaked in March 2009, at the very same time as global equity markets hit their lows!

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Anonymous
admin
October 30, 2016 at 5:02 AM ×

Trump is hilter, Trump will start ww3, Trump will launch nukes, Trump will start gfc 2...

The US election is a joke but the joker is not Trump...

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checkmate
admin
October 30, 2016 at 9:15 AM ×

"Investors would shun US assets such as stocks and bonds."
Of course they would. It would be a mad scramble to buy gilts. I would be selling my 'Manshed' for the price of a Hollywood mansion to a desperate Saudi Arabian Prince Surely everybody can see that.

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Anonymous
admin
October 30, 2016 at 12:03 PM ×

Checkmate, what are we talking here? A dartboard, an old cortina up on blocks, an aldi mig welder and air compressor still in their boxes in the corner? I can make an offer if you are interested now the AUD is worth 0.62p.

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checkmate
admin
October 30, 2016 at 3:43 PM ×

You can just make out the dartboard in the corner.
http://amdega.co.uk/classical-orangeries.asp

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Nico G
admin
October 30, 2016 at 11:14 PM ×

anon 10:57

Happy to entertain. I did not post to brag but to counter what sounded like discouragement from LB. He is not the only one, the Evil Speculator and many other respected technicians are also going cuckoo these days. Saloon doors, stoprun galore, chop all you want but this market is still very easy to scalp with just intuition. I am not here to teach you how. The 150 lots are trailing profit from 2162 and it's boring. One needs scalping i.e. active trading on the shortest timeframe to keep a feel of the tape. That feeling you develop by watching price tick by tick for twenty years, not by buying subscriptions.

There are a couple of smart posters here, but i don't see the point in paying quoique ce soit. MM and i are not best friends and i only respect those who make a living from trading not from selling trading books, private letters or blog subscriptions. Our professor at the Actuarial institute could price the most complex derivatives, but never made one profit on the market. He was a fool. Today a real track record can be clocked at eToro for those who seek to manage others' money. I like the Evil's humour but would never pay him a penny. Why does he need subscriptions if he is making so many good calls? If he, like many others, dread the solitary confinement of online speculation well he can just keep a free banter place going. I personally will open a bar restaurant in Hawaii and avoid financial types.

I am not here to advertise anything, i am here to advocate caution. This market is incredibly dangerous and many young folks who have only traded the way up simply cannot know the pain of a sustained downside. That is all. The picture in the US is about to get very complicated no matter the election outlook. I was right on European banks. I called the Chinese top and shorted it (sorry washed i kept my shorting instrument secret). I was right on Brexit. I made tons of money. I was wrong for so long on the spoos but i ain’t stupid, i never fought the tape since European banks behave like a real bear market and gave plenty of short$$$ for two years. There was no need to fight the Fed BUT i can feel spoos are finally topping. It is just taking a gazillion years to roll over.

Im happy to manage my own money with no office no email no telephone no residence and no friend from financial forum. The great Dominic Mazza died in 2008 i have not followed anyone ever since. If you want to make specualtion your sole, perennial revenue you CANNOT count on anyone else but you. For any source you need to make $ may retire or die and leave you without a personal trading method. I hope this makes sense. Keep on laughing! One good laugh a day keeps le docteur away. I hope you understand none can boast a track record through ipso facto comments on a forum. Such exercise is futile. Now some folks who’ve dwelt long enough in this hood know the good calls i made. Good luck for the weeks to come Mr Market will be merciless.

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Anonymous
admin
October 31, 2016 at 6:48 AM ×

dont worry about it nico long time readers (or lurker like me) appreciate your input - always worth reading.

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Macro Man
admin
October 31, 2016 at 10:56 AM ×

@ Nico If you cannot respect the proprietor of this establishment, or indeed follow the rules of engagement, why have you returned? While your input has been valuable on occasion, following your logic mine has not. Can you not resist coming down from the mount, with your wisdom inscribed on stone tablets for the benefit of the worshipers...or is everyone you know in real life bored to tears by your stories of trading prowess and bedroom exploits? Perhaps you should spell your name N-ego.

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Anonymous
admin
October 31, 2016 at 5:19 PM ×

The results detailed in that observed betting pattern paper seem almost unbelievable to me.

I have never heard of the "Kelly criterion" (and even after reading the paper, I still don't understand why a log utility of wealth is required for the optimal strategy to actually be optimal), but finding the fraction to wager that maximizes profit from the game is a very straightforward calculus problem, which (when a similar problem was posed as a brainteaser) I solved at least a couple of decades ago.

Wish I had had the chance to participate in that experiment (one seldom has that certain, or that large, as measured by the time interval, of an edge), even with the profit limitation (it simply would have been fun).

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