Calling time on the global bond rally has been a fool’s errand since at least late March, and this week saw a continuation of manic rates moves and a perpetuation of the duration infatuation (how’s that for alliteration?).
Although some are cooling on the rally, as long as the economic backdrop remains uncertain and the trade situation tenuous, the bid for bonds is likely to stick around.
Unfortunately for equities, recent price action suggests any mechanical/formulaic boost stocks should enjoy from lower bond yields is prone to being offset by what it is the bond rally signifies – namely, expectations for a global downturn.
As BofA writes, in the latest edition of their FX and rates sentiment survey, “UST duration longs were extended aggressively after the most recent escalation in the trade war”.
In fact, the bank observes that we’re now “just shy of the Sep-2007 record” and have already shattered the record “of the most sustained duration overweight by a full three months” with the current streak at nine versus the old record of six in March 2009.
In the same survey, respondents overwhelming favored 10-year Treasurys when asked for their opinion on the most effective risk-off hedge. 47% chose USTs, versus 34% last month, while 36% said SPX puts. Only 6% chose the yen, down from nearly a quarter of respondents in July.
Meanwhile, expectations for central banks have similarly been pushed to extremes. 22% of respondents now see the Fed cutting rates by >150bps by the end of 2021, while a full 50% of those surveyed see the ECB both cutting rates and restarting QE in September.
Unfortunately for policymakers, the more entrenched these expectations become, the more lopsided the positioning in rate cut bets and duration longs. The more lopsided that positioning, the larger are the risks associated with disappointing markets.
That’s the “hall of mirrors” effect and it creates a feedback loop:
As things currently stand, central banks are having a hard time figuring out how to break free of that. For now, anyway, the exit from this self-fulfilling prophecy appears to be blocked.