(Re)Balancing Act Bolsters Treasurys Into Year End

One question going into a week in which the tape was painfully thin across the board was whether rebalancing would have a demonstrable effect on markets and/or continue to fuel a reversal of the “buy stocks”, “sell bonds” trade that characterized the weeks following Donald Trump’s election.

Well, it does indeed appear that rebalancing flows played a role on Thursday and also on Friday as Treasury yields dipped to post-FOMC lows. As Bloomberg noted this afternoon, “volumes surged into the futures close, [and] included a 5Y block trade with ~$435k/DV01 [as well as] ~80k 10Y contracts traded over a 3- minute period.”

It’s also possible that this week’s well-bid 5Y and 7Y auctions were bolstered by investors looking to meet their month-end targets.

Here’s Morgan Stanley with some brief desk commentary:

Much of the month/quarter/year-end demand for bonds from index duration extension and portfolio rebalancing seemed to have gotten done before Friday’s abbreviated and lightly attended trading session at the very strong 5-year and 7-year auctions and buying surrounding them on Wednesday and Thursday. But there was still a decent bid after mid-morning Friday in thin rates market trading before the early close that accelerated shortly before the 1:00 futures close and sent yields to another day of post-FOMC meeting lows across the curve. Outperformance by long-end futures versus slightly softer stocks suggested pension rebalancing activity continuing, and rising index extension related buying was noted by our desk after some light morning selling and moves into steepeners. There has seemed to be a widespread sentiment among fast money investors and real money investors who make active duration bets of wanting to be positioned short the market moving into 2017, but such investors have generally, it seems, decided to stay out of the way of the month-end bid, or been pushed out of the way in the short covering following the 5-year and 7-year auctions, while waiting for more liquid conditions to resume next week to establish or add to positions looking ahead to 2017.

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