“It’s None Of The Above”: One Trader Answers The Big Question

On Saturday, we said the following about the dramatic change of heart apparent in spec Treasury positioning:

On Friday, we got the latest CFTC positioning data (current, as usual, through Tuesday) and guess what? Specs flipped to their heaviest long TY position since 2008.

“They sharply covered Treasury shorts from 5Y out to Ultra bonds, notably across TY futures where positioning flipped to net long,” Bloomberg wrote on Friday, adding that “in 10Y futures, speculator accounts added $20m/DV01 total duration in the week, or ~255k contracts, covering shorts and building longs.”

Make no mistake, this is notable.

And it was – notable, that is.

The common sense read on this is that the massive short was continually burned by lackluster data, an administration that can’t seem to get anything done with regard to the growth-friendly agenda that got Trump elected, and a Fed that wasn’t very convincing when they hiked in March. Here’s an annotated 10Y chart:

10YAnnotated

While all of those explanations for the sudden sharp reversal in spec sentiment are certainly plausible, former FX trader Richard Breslow thinks we might all be missing the forest for the trees.

Read below as Breslow explains why “none of the above” is the answer to the question, “why is everyone running to cover their Treasury shorts.”

Via Bloomberg

Much has been made of last week’s curious CFTC positioning report with regards to 10-year Treasury futures. And with good justification. Not only did speculator shorts continue to cover, but they added significant new longs as well. As a class they are actually net long for the first time since last year. And in size. Even more interestingly, some would say alarmingly, the 30-year future showed much the same inclination.

Spec

  • The question is why? Do traders really think the economy has seen its best days? Have they been well and truly spooked by the meh economic data? Are they betting the Fed has again been too optimistic in their forecasts and is due for yet another comeuppance? Is geopolitics just too scary for animal spirits to roar to life for long? Has R* changed the game for good? It’s none of the above
  • The answer is all about how you build a portfolio. No asset class is an island. And few traders who don’t live within commuting distance of the options pit at the CME will prosper for long just punting around the 10-year in isolation
  • Being long bonds, or certainly less short bonds than would otherwise seem reasonable, is proving to be just too good a hedge for the higher beta, risk-on assets investors have an insatiable appetite to buy. It just doesn’t matter what you think about valuations for happy instruments, they’ve simply done nothing wrong. And benchmarks take no prisoners
  • You have to get your head around the fact that bond buying isn’t at all necessarily a sign of concern but an indication of an inclination to ramp up other risk taking investments. Those cash hordes being put to work. Talk about mixed signals
  • Look around: equities, emerging markets, credit, carry, all continue to thrive. Danger on the Korean Peninsula? Yes, and the Kospi is looking at all-time highs. It’s a common theme. And every time there’s a hiccup, your bonds rally
  • But that’s not all. Investors aren’t fully convinced by central bank protestations that they’re not obsessed with financial conditions measures. As long as that continues, being long risk and bonds isn’t a Texas hedge, it’s good risk management
  • With this paradigm firmly in effect, it makes sense that bonds find bids when yields back up in any kind of orderly fashion. Ten basis points just isn’t dramatic enough to materially hurt well-diversified, positive carry, portfolios. The only thing that will challenge this pattern is if and when investors believe yields aren’t only going higher but materially so, quickly and for a sustained period
  • On the other hand, it also causes fixed income investors all along the yield curve to steeply discount, even disregard, coming rate hikes, balance sheet normalization, potential fiscal stimulus and a second quarter GDP that may look nothing like the first quarter
  • Buying bonds makes perfect sense, but only for the right reasons and that, bizarrely enough, is predicated on good, but not too good, news. Precisely the message FOMC watchers expect to hear through this week’s communications
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