With the duration infatuation/bond love affair in full swing, one persistent worry has been that some left-field catalyst (or combination of catalysts) will come along and trigger an unwind in crowded positioning.
Generally speaking, everyone had decided that a “rogue” inflation print would not (could not) be that catalyst. After all, inflation is dead, right?
Apparently not, judging by the hottest MoM core CPI print since January 2018, which came calling on Thursday morning, 24 hours (on the dot) after Jerome Powell’s prepared remarks to the House Financial Services committee effectively cemented a July rate cut. Fast forward to Thursday afternoon, and we got an ugly, tailing 30-year auction, with a lackluster bid-to-cover (2.13 versus 2.32 previously). Primary dealers were forced to take 33.2% of the issue. 30-year yields jumped, and are now up 8bps on the day.
Obviously, this doesn’t say much for the “faith” part of the “full faith and credit” promise, and coming as it does on a day when yields were already on the rise following the CPI “shocker”, the result is a pretty substantial bond selloff. Folks seem to be coming around to the possibility (however remote) that inflation might come calling after all, especially if the Fed is willing to cut rates despite solid data (and don’t forget the tariffs). 10-year yields were higher by some 7bp on the day.
It doesn’t do anybody any good to wax hyperbolic/hysteric about this, but it is worth noting that a violent selloff in bond land or some kind of vicious bear steepening episode likely wouldn’t be digested well.
Earlier Thursday, Nomura’s Masanari Takada cautioned that after the July FOMC, it’s possible that “CTAs and other speculative players will start exiting their long positions in US bond futures in earnest”.
And then there’s the risk parity crowd. “Risk-parity funds are off to their best start since at least 2004 after ramping up exposure to government debt and levering up, while trend followers in interest rates just notched the strongest half-year in nearly three decades”, Bloomberg wrote earlier today, in what now looks like a fortuitously-timed piece. “But the pile-on in Treasuries has left quantitative and discretionary investors alike at the mercy of a bond market that can turn on a dime”.
Indeed it can “turn on a dime”, as illustrated by what happened on Thursday.
Remember, “long USTs” was the most crowded trade on the planet according to BofA’s June Global Fund Manager survey.
(BofA)
Back on June 25, Nomura’s Charlie McElligott noted that according to his QIS model, risk parity’s global DM bond allocation was still lingering at its highest levels since 2011.
(Nomura, Bloomberg)
You can take all of the above for what it’s worth – which may very well be nothing – but the bottom line is that the ingredients for a “tantrum” have been in place for weeks on end, and with no shortage of kindling scattered about, all we’re waiting on is a struck match.
Question: Is it the case that equity markets generally outperform when the yield curve is “bear steepening”? I had thought that was the case. And if bear steepening were to occur for a period of time, I wonder if this would cohere with the theory that we are headed towards an equity “melt-up” here in the latter part of summer/fall?