So obviously the bund selloff was the Thursday’s biggest story.
In many ways, what we saw just after 5 a.m. EST was the sum of all fears for those concerned that another “tantrum” episode may be in the cards.
A relatively innocuous catalyst triggered a sharp move higher in yields which immediately spilled over into DM bonds across the board and weighed heavily on equities.
Of course higher DM yields also bodes poorly for EM, another stretched trade.
Ultimately, bund yields hit their highest levels since January 2016:
The question now is whether this has further to run and, if it does, whether that will add fuel to the fire in terms of the extent to which rates pose a risk to overbought equities, causing a concurrent selloff that could end up triggering the dreaded risk parity unwind.
Below, find the latest from Citi’s Harvinder Sian who, when it comes to European rates, is generally on top of things…
How far for the Bund sell-off?
The sell-off has led by 10yr and in the process Bunds have broken some key levels begging the question of how far a sell-off could go. That depends on tactical factors, positioning and valuations.
Figure 5 shows the spread between constant maturity 10yr Bunds and 3m € OIS. This reached a peak of 111bp in 2015 at the height of the Bund tantrum. A similar spread level today would put Bunds at 0.70%.
Chart technicals became more bearish after breaking 0.51% (Figure 6), which has survived two or three tests already this year. This suggests a technical target of 0.86%.
Positioning: we said last week that 95% of the global duration longs were underwater and that this would extend the sell-off. The market has subsequently seen stops and some movement to being short duration. Our Rates Position Monitor showed a clear out on tactical longs to the tune of $24mln, and the latest data shows a new $3m DV01 short base.
Figure 7 shows the futures and cash positions for Europe. The normalized position is from a range of -5 to +5 and for German risk stands at -0.6 and with -2.8 in Bobl and near flat in Bunds (-0.1). The Normalized P&L shows whether this position is comfortable or not. It shows for instance that the Bobl shorts are sitting on profits of +2.5. The market is net long BTP, OAT and OATs against that.
- A further sell-off in German paper from here will be driven by an increasing short base and is made possible by the fact that the net RX positon only moved today to a short.
- A build-up of shorts however becomes vulnerable to a slow-paced ECB signaling process at the July 20th meeting and ongoing low-inflation. That will matter for negative carry bear trades as the German curve gets increasing steep and as repo can start to richen again on those shorts.