Fresh off Tuesday’s sweeping assessment of the extent to which Fed communications (and the prospects for a reverse Operation Twist now in the interest of freeing up space for a sequel to the original Operation Twist later), stimulus efforts out of China, a suddenly soggy greenback (helped along by the idea that the currency stability pledge embedded in the Sino-US trade pact is a weak dollar policy proxy) are together conspiring to reinvigorate a “rentable” reflation trade, Nomura’s Charlie McElligott is out with some quick thoughts for market participants on a day when everyone is glued to split-screen, live coverage of multiple congressional testimonies.
You’ll recall that part and parcel of Charlie’s recent narrative is a burgeoning steepener which he thinks has the potential to take off on the back of two possible catalysts, one being a material weakening in the data which would pull forward expectations for rate cuts, prompting bull steepening. The other is the converse, where the reflation catalysts he highlighted on Monday gather more momentum, prompting bear steepening.
On Wednesday, he’s pleased with the 5s30s making fresh 12-month wides near 58bps. Channeling Hannibal Smith, McElligott writes the following:
I love it when a plan comes together: The UST yield curve steepener I’ve been pushing continues to run, with 5s30s making fresh 12m highs / wides (57.7bps last) and 10s30s at 27m wides.
While at the same time over the larger sense, the broad UST complex has continued to rally (however weaker today on some Corporate IG issuance coming to mkt / rate-lock hedging), as CB “dovish capitulation” off the back of the global slowdown further metastasizes into a front-end rally (especially as funding mkts continue their recent collapse–LIBOR, SOFR and CP rates).
He also notes that STIR traders continue to price in easing at the margin in 2020 (now nearly a full cut priced in). The steepening is playing out against the global slowdown narrative which is obviously bullish for bonds. How bullish, you might fairly ask? This bullish, Charlie notes:
- JPMorgan’s US Treasury Investor Sentiment Index this week made new highs since Sep16, a +2 Standard Deviation “bullishness” relative to the past 5 years
- The Nomura QIS Risk Parity model $ notional allocation to USTs sits at highs last seen in May13, while the overall Global Bond $notional is at our series highs dating back to at least 2011
- The Nomura QIS CTA model as of this morning shows an almost consensual “Max Long” across global DM Bonds: “+100% Long” in USD 10Y, JPY 10Y, CAD 10Y, CHF 10Y, FRA 10Y and ESP 10Y, while EUR 10Y, GBP 10Y and AUD 10Y are all “+95% Long”
Needless to say, this kind of consensual infatuation with bonds could become “an issue” (to quote Charlie) if the data were to suddenly inflect. That would go double if that inflection were to manifest itself in above-consensus inflation prints.
In the same vein, McElligott notes that the massive bond long is “counterintuitive” given the burgeoning reflation narrative and subsequent “gathering of steam” in the trades that would benefit if that narrative were to prove sustainable.
“At the same time of the global-growth slowdown drives this UST bull-steepening, we are seeing 5Y Breakevens continue to widen to new 3.5-month highs and nearly +40bps now since start of January 19, as ‘TIPS over Nominals’ gains steam”, he writes, before reiterating that recent dollar weakness is clearly contributing to the “reflation impulse.”
In any event, the question the above raises – or at least from where we’re sitting – is whether an inflection in the inflation data and a subsequent unwind in what Charlie calls the current “DM bond love affair” could help turbocharge any bear steepening in line with the following quote from Tuesday’s note:
We see this “reflation-impulse” from the triple-impact of 1) the still-developing Fed inflation framework shift; 2) the de-facto Fed “easing” which has already occurred after pivoting away from B/S QT and forward-guiding towards “even odds” on either a cut or hike; and 3) the PBoC’s credit- / liquidity- surge gain further steam and this would alternatively likely drive a “bear-steepening” driven by long-end yields repricing inflation relatively higher than any hiking impact in the front-end—especially in light of the Fed’s new inflation framework shift to “run hot” on inflation.
Just something to kick around.