That’s become a familiar joke these days whenever bonds rally.
There’s been no shortage of handwringing this year about “magic” numbers on 10Y yields and “pain thresholds” beyond which the stock-bond return correlation flips sustainably positive imperiling risk parity and balanced portfolios more generally as diversification desperation kicks in.
Dozens of analysts and commentators have weighed in with their thoughts over the course of what has been the worst start to a year for 10-year Treasurys since 1931:
We’ve been over this debate more times than we care to count, but suffice to say that up to 4% or maybe 4.5%, it’s the “why” and the “how” that matters for stocks when it comes to rate rise, not the absolute level. That is, is it “good” rate rise (e.g., on the back of rising growth expectations) or is something else behind rising bond yields? And on the “how” point, the issue is one of rapidity. Recall this from Goldman out last week:
The pace of yield increases – not just the magnitude – is also an important determinant of equity performance. Historically, S&P 500 has struggled to digest monthly interest rate increases of more than 1 standard deviation relative to the past three years. Equity returns have typically been flat when 10-year yields have risen by more than 1 standard deviation in a month (roughly 20 bp in today’s terms) and negative when yields have risen by more than 2 standard deviations (40 bp currently; Exhibit 2).
You can read our most recent exhaustive take on this debate here, but the point on Friday is to remind you that “short USTs” is the second-most crowded trade on the planet according to BofAML’s most recent Global Fund Manager survey:
Here’s what that looks like (although it will change with the latest CFTC data later Friday):
For a while there, that trade was looking bulletproof as 10Y yields rocketed to their highest levels since 2011 in the wake of last week’s retail sales data. Reals hit their taper tantrum peaks around the same time. Fast forward to Friday and we’re a long way from where we were a week ago:
Now recall how breakevens have been slavishly following crude:
Well given Friday’s steep selloff in oil (as the Saudis apparently cave to Twitter pressure from Trump), you can probably infer what’s going on with breakevens. Here’s a week chart:
All of the above raises questions about whether that short Treasury position might be getting squeezed. It was just a little over a week ago when Goldman suggested that bond bears shouldn’t be overly concerned about stretched positioning being a contrarian indicator. They did offer the following caveat:
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.
Whether what we’ve seen this week is the beginning of an unwind in the bond short remains to be seen, but it’s definitely worth asking if perhaps a sudden move lower in oil prices could serve as just the type of “new fundamental information” Goldman mentioned.