Right, so on Tuesday, equity investors were reminded that while rising 10Y yields might not spell disaster for stocks until 4% or maybe 4.5% or maybe even 5%, the rapidity with which yields rise matters and it matters a lot.
Fortunately, the selloff stalled overnight, but the story here remains the same. 10Y yields are sitting near their highest levels since 2011 and perhaps more importantly, reals continue to test the dreaded Taper Tantrum highs:
One thing more than a few folks have suggested is that stretched positioning will eventually act as a brake on this. The following is sometimes a contrarian indicator and indeed, if you want proof of how horribly wrong this kind of spec crowding can go, look no further than how stretched these same short positions were at the start of 2017:
So is that a headwind for the bond bears who, as Michael Hartnett reminded you in the latest edition of BofAML’s Global Fund Manager survey, are now sitting in the second-most crowded trade on the planet?
Not necessarily, according to Goldman, whose rates team is sticking with their year-end target of 3.25% on 10s, informed, in part, by their persistent argument that the term premium is too low.
“A common concern among investors―and a rejoinder to our view―is that positioning has become too crowded,” Goldman writes in a note dated May 14 and thus a note that seems particularly prescient in light of Tuesday.
“The market, the argument goes, cannot build up duration shorts indefinitely. The rising risk of a correction means that bonds are unlikely to sell off much further from the current levels,” they continue.
The above-mentioned Hartnett said something similar in a Tuesday interview with Bloomberg:
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.
And here’s what we had to say about all of that in a post for Dealbreaker:
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.
Now here’s Goldman explaining why crowding may not be a significant headwind for bond bears:
We do not think that positioning is a significant threat. For one, we do not find that positioning is as stretched as the unadjusted data on net speculative length imply. On a better metric―net speculative length scaled by open interest―positioning does not appear as extreme. At around 12%, the market is still some 5 percentage points away from the historical peak in shorts, roughly the distance of a standard deviation.
Moreover, extreme positioning can be persistent. As Exhibit 2 shows, after net shorts reached a historical peak in March 2010, it took the market around 8 weeks to unwind them by 5 percentage points and another 10 weeks to cut further from the elevated 10%. The pattern is not limited to one episode, with similarly extreme positioning remaining extreme for months.
And if you don’t buy that in the context of doubting the notion that stretched positioning is a contrarian indicator, then maybe you’ll like what Goldman says next better. Specifically, they note that if you care about statistics and history, then you might be interested to know that there’s no evidence to support the notion that spec positioning tells you much about where 10Y yields are going.
“Most important, there is little statistical evidence that positioning data tell us anything about where yields will settle in the future, either by themselves and certainly when controlling for macro fundamentals,” the bank continues, before adding that “in the data since 1994, net speculative length (as percent of open interest) has forecast about 2% of the movements in 10-year Treasury yields over the next six months [while] core CPI inflation, has explained around 1/3.”
There’s probably some reverse causality going on in there somewhere, but you get the point.
Of course Goldman does acknowledge the obvious, which is that if shit starts moving against those trades (i.e., if out of the blue, something catalyzed a voracious bid for bonds), the unwind could accelerate things.
“Momentum-driven swings in aggregate positions can significantly amplify yield movements, over and above the levels required to price in new fundamental information and for investors with tight stops, even mild shifts can be consequential,” they remind you.
And on that note, just remember what happened at 3 pm on February 5 as the bottom fell out for equities…