Implicit in the incessant speculation (no “spec” pun intended) about 10Y yields, where they’re going, and what it means for markets and the Fed is one simple question: who or what is behind the Treasury rally?
Now obviously, one answer is short covering….
…and another answer is a dovish Fed hike and a loss of confidence in the reflation narrative as policy uncertainty rises in Washington, investors wake up to the “hard” data reality that lies beneath the “soft” data euphoria, and geopolitical risk rears its ugly head …
But there are other possible explanations – such as Japanese investors coming back to market now that hedging costs have come in and the FX environment is favorable, etc.
Well, BofAML thinks they may have solved the “mystery.” Read below as the bank explains “who’s behind the FOMC rally.”
Our latest flow report suggests three groups of investors have been driving the recent decline in Treasury yields: 1) high frequency data (custody holdings at NY Fed) show that foreign official investors bought ~$40bn UST since the beginning of March, repeating what they did Dec 2016 when the Fed hiked rates; 2) levered funds cut shorts in futures space – reducing their positions by $24bn in 10y equiv. in the second half of March (and $18bn for the whole month); and 3) bond mutual funds continued to see inflows (~2 zscore) while equities saw record outflows following the rate hike.
While still early, we think all three deserve extra focus given they mark distinct shifts from their longer term trends – note that official investors have been consistent sellers over the last year, asset manager positioning has proved more vulnerable than levered funds, and equity funds inflows have weathered multiple risk events. Whether March marks the shift in trends or a blip on the radar remains to be seen in coming weeks.
Japan private investments in foreign bonds finally printed positive in March as a result of the $9bn purchase in the last week.
Charts to highlight: Chart 4 the reduction in net positions by leveraged funds were concentrated in TY contract.
Chart 11: Foreign official investors have added UST in recent months.