Here’s What Went Wrong For Bill Gross This Week And Here’s Why The Trade May Continue To Move Against Him

Listen, Bill Gross isn’t really feelin’ your snarky ass comments about the terrible, horrible, no good, very bad day, he suffered through earlier this week amid the selloff in Italian bonds.

As you know, Tuesday was the worst day for Gross’s Janus Henderson Global Unconstrained Bond Fund since inception.

While no one knew precisely what went wrong there, I suggested that perhaps Bill was short bunds (again). Specifically, as part of my postmortem, I said this:

It’s worth noting that Gross made headlines back in 2015 (during the bund tantrum) for his bearish stance on safe haven German debt. Specifically, he called bunds “the short of a lifetime.” Well, 10Y yields in Germany fell below 0.20% on Tuesday, in another manifestation of the flight to safety.

“Investors should look for 3% plus or minus on the 10-year for the balance of 2018 [and] that level should ultimately force German Bunds to higher yields, perhaps 1%”, he wrote in March.

Yes, “perhaps 1%.” Or “perhaps” 0.19%.

I also suggested that the rally in Treasurys might be partially to blame.

And because I, like Donald Trump, “have said a lot of things“, I can also trot out some quotables and charts from a post published last Sunday that, as it turns out, help to explain what happened to Bill this week. Here are some excerpts from a little something I did on policy divergence and rate differentials last weekend:

[For a while], the dollar stubbornly refused to keep pace with the favorable shift in rate differentials (thanks in part to market jitters about the deterioration of the U.S. fiscal position and the extent to which Trump’s trade stance amounts to a weaker dollar policy by proxy), but the correlation between the greenback and U.S. yields and also between the dollar and rate diffs has begun to reassert itself of late.

Do note that between decelerating growth in the eurozone and the safe haven bid associated with political turmoil in Italy and now Spain, German bunds just had their best week since 2015:

And while U.S. yields fell from recent highs during the week, that 254bps spread between 10Y Treasury yields and 10Y German yields you see on the blue line in the first chart shown above is the widest level since 1989.

Again, that’s from last Sunday.

Well, that spread widened out even further at one point this week:

(BBG)

According to Gross himself, that’s what did him in. Here’s Bloomberg:

“The strategy has been to be short the German bund and long U.S. Treasuries,” Gross said Friday on Bloomberg television. “That was the basis for the bad day and the bad trade.”

Gross has been betting the gap would narrow, but this week the extra yield investors demand to hold 10-year debt from the U.S. rather than Germany reached the most since 1989.

“Italy affects German bunds because ultimately if Italy decides to leave the EU the consequences are severe,” Gross said.

The yield premium that 10-year U.S. notes offer over equivalent German debt has climbed to more than 250 basis points, from less than 200 at the end of 2017. Safe haven buying on Tuesday helped send the yield on Germany’s 10-year note to just 0.19 percent, its lowest intraday level in more than a year.

Now look, I don’t know the exact details here, and I’m not a guy who likes to say “I told you so” because I’ve said so many things that turned out to be entirely wrong that it would be extremely disingenuous to selectively tout the “right” calls (although I did gloat quite a bit about the VIX ETP blowup and the realization of the “doom loop“). But do note that bolded passage in the excerpt from the Bloomberg piece and then read the following again, from my post published on Wednesday:

Yes, “perhaps 1%.” Or “perhaps” 0.19%.

There you go.

Going forward, I guess what I wonder is how confident Bill really is in the notion that, as he told Bloomberg, “the widening of the U.S.-German spread has to reverse.”

If the ECB is effectively forced to reassess their normalization plans by i) rising tensions between Italy’s new government and the core, ii) Spain going back to the polls, and/or iii) both, the proposition that Draghi will be able to move confidently ahead seems tenuous.

And remember, that’s only part of the equation here. Today’s econ out of the U.S. pretty clearly suggests the U.S. economy is on a different trajectory than the eurozone economy with the latter perhaps having peaked in Q1 (this week’s upbeat inflation data notwithstanding).

If the jolt from late-cycle fiscal stimulus continues to deliver a sugar higher stateside and wage inflation shows up, it’s not hard to imagine a scenario where the policy divergence theme between the Fed and the ECB reasserts itself with a vengeance. All of that would move rate differentials even further in favor of the dollar and, on the surface at least, against Gross.

This appears to be, at heart, a trade on Bill’s view of how the policy divergence between the Fed and the ECB will evolve. His reasoning (if you listen to the BBG TV interview) seems sound, but just because the reasoning is sound doesn’t mean it will work.

Think about last year, for instance. In 2017, two consensus policy divergence trades (“long USD” and “short USTs”) went horribly awry as Europe held up and the market began to fade Trump’s fiscal stimulus ambitions. Sintra only accentuated things. By the time August rolled around, 2017’s policy divergence theme had morphed decisively into a policy convergence theme.

Now we’re back to divergence and he’s seemingly taking the opposite side of that trade (he says as much in the interview).

As for the media’s coverage of his bad Tuesday, he called it “ridiculous”.

Draw your own conclusions.