So you wanna short Treasurys, do you?
Of course you do. Everyone does.
In fact, according to the latest Global Fund Manager survey from BofAML’s Michael Hartnett, it’s the second-most crowded trade on the planet behind “Long FAANG+BAT” which has taken the top spot for four consecutive months as people continue to “buy the damn robots” despite mountainous evidence that some of those “robots” might have inadvertently conspired with the Kremlin to spy on you and despite the fact that those “robots” are likely to come under heightened regulatory scrutiny going forward.
If Trump were a rates strategist (and you can bet that just like his autocratic soulmate in Turkey, he’s going to pretend to be a rates strategist in the event Jerome Powell ends up hiking enough to lop a couple thousand Dow points off), he’d call it a “tremendous” trade. And he’d tell you that “a lot of people are saying that.”
And he’d be the one to ask because you know, one reason why folks are betting on rising yields is because Trump’s deficit-funded tax cut means Steve Mnuchin has to flood the market with supply at a time when the demand side of the equation is in question.
Steve isn’t worried, but with the Fed running down the balance sheet, more of that supply is going to have to be absorbed by price sensitive investors, which means there will be actual price discovery, which in turn means higher yields in an environment where the U.S. fiscal outlook is deteriorating rapidly.
That’s the bad side of rising yields. The “good” side of rising yields is that to a certain extent they reflect the relatively rosy growth outlook for the U.S. in stark contrast to the decelerating European economy.
So what could go wrong? Well, a couple of things. For one, folks could interpret yield rise as “bad”. Here’s the above-mentioned Michael Hartnett:
What shakes consensus? Weak US Q2 GDP and/or ‘bad’ rise in rates.
“Bad” rise in rates could entail a safe haven bid if a bond selloff ends up spooking equities enough. In other words, you could get a repeat of what happened just after 3:00 pm on February 5, when bonds rallied sharply as the bottom fell out for stocks.
And see that gets back to the veritable laundry list of reasons why the U.S. long end could continue to find sponsorship. Just about the last thing central banks want is for rates vol. to spike. If you get a sudden surge in rates vol. and/or an unanchored long end, then the bond trade unwind tail risk could be realized and that’s a non-starter for policy makers. Effective forward guidance is set to take the proverbial baton from QE now that both the “stock” and “flow” effect from asset purchases have peaked. That forward guidance, if effective, allows central banks to remain “the largest vol. sellers in the market” (to quote BofAML’s Barnaby Martin) and thereby suppress volatility across assets by ensuring rates vol. doesn’t spike.
Additionally, the Fed seems to be attempting to pull volatility back to the front end of the curve. As Deutsche Bank’s Aleksandar Kocic put it in a note out Friday, “the Fed is daisy chaining the two ends of the curve with the equities market, effectively buying back convexity from equities, recycling it through the front end and sending it as convexity supply to the back end of the curve.” Again, the idea here is to reduce the tail risk of a sharp rise in long rates.
But for the time being, the bond bears are having their day in the sun after Tuesday morning’s retail sales data sent the dollar and yields higher. Specifically, 10Y yields hit their highest since 2011.
That did not abate and in fact got materially worse as the session wore on.
In an interview with Bloomberg, BofAML’s Hartnett said the following:
The short Treasury trade has become more extreme. As Treasury yields finally slice through 3 percent, more likely people will add to that than reduce it.
That’s fair enough, but remember that the more extreme the positioning, the more likely it is to be a contrarian indicator.
So you know, “step right up folks,” and pile into one of the most crowded trades on the planet which, given the recent restoration of the dollar’s correlation with 10Y yields and rate differentials, is conspicuously inconsistent with the third-most crowded trade in the survey mentioned above.
Let us know how it works out for you.