Heisenberg Report

It’s ‘August In Reverse’ As Bond Selloff Worsens

On Monday evening, we asked if the bond selloff might have further to run, and if it did, what that might mean for markets.

One of those questions was seemingly answered on Tuesday, as the rout continued stateside. This comes with the obligatory caveat that given how littered with risk-off land mines the path forward most assuredly is, all it would take is one tweet to catalyze a flight-to-safety bid for bonds.

TLT has now fallen >1.5% in three of the last four sessions. It’s on track for the worst month since Trump was elected. That marks quite a turnaround from August.

10-year yields have risen ~30bps in a week, and sit near their highest levels since early last month.

Read more: What Happens If The Nascent Bond Selloff Has Legs?

Bonds were pressured on Tuesday by a continuation of the deluge in corporate supply and a $38 billion 3-year auction which came ahead of Wednesday’s 10-year reopening and more supply on Thursday.

It’s “August in reverse”, BofA’s Hans Mikkelsen wrote on Tuesday evening, describing the retracing of last month’s plunge in yields. He also updates the September totals for the high grade primary market in light of Tuesday’s action. “The market continues to be very busy with $13.6 billion priced across 14 deals today, bringing us to $27.8 billion WTD and $104.0 billion MTD”, he notes. Last week broke records.

“US Rates really bore the brunt of a massive supply spree last week with $82 billion issuance between Corps and Foreign Govies, but also no doubt too the late last week spate of US ‘upside surprise’ economic data, all of which caught a US Rates market ‘priced for the end of the world’ somewhat flat-footed”, Nomura’s Charlie McElligott said Monday, adding that if you ask him, it “reiterates just how much of this Rates rally in recent months has been from mechanical sources like ‘price-based momentum-‘ and ‘convexity hedger-‘ flows”.

Last month, JPMorgan’s Josh Younger said “the magnitude of convexity hedging YTD is likely the largest of the post-crisis era”.

(JPMorgan)

It thus makes sense that yields perhaps fell further than can be explained by fundamentals alone.

One of the biggest worries for bond bulls amid the burgeoning rout is that Mario Draghi will underwhelm on Thursday. The bar for a dovish surprise is generally seen as very high, and recent pushback from officials on the idea of restarting net asset purchases in Europe has made some market participants rethink their assumptions for the ECB meeting.

Spillovers from Europe have gone a long way towards explaining the relentless grind lower in US bond yields in 2019, so any disappointment around a resumption of ECB QE could serve as fuel on the fire for what’s quickly turning into a pretty acute bond selloff both in the US and in Germany, where 10-year bund yields have retraced 20bps from the lows.

Meanwhile, the short-end in the US is repricing too. Bloomberg’s Cameron Crise notes that positioning is likely at play. “The nominal speculative eurodollar long is at record highs, and as a percentage of the open interest it’s back to the neighborhood of the financial crisis”, he wrote Tuesday. “That means that once the music stops on the rally, there’s a helluva lot of people scrambling for somewhere safe to sit”.

Read our ECB preview: As ‘Super Mario’ Steps Up To Bat, ‘Markets Are Vulnerable To A Correction’

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