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As ‘Tantrum’ Risk Comes Calling, Nomura’s McElligott Flags CTA Bond Selling As Legacy Long Unwound

Trade optimism is running rampant and crowded positioning looks set to unwind.

Markets are buzzing with “tantrum” chatter again amid a fairly large selloff in bonds, where yields have risen sharply since the late-summer lows.

Trade optimism has helped catalyze a rotation into risky assets and there’s a palpable sense (“sense” = anecdotally speaking) that at least some market participants are starting to put a little faith in the idea that the coordinated easing push from global central banks is on the verge of manifesting itself in better growth outcomes.

In France, yields are nearly back to zero, and look poised to turn positive again for the first time in months.

In addition, the Fed has telegraphed a desire to stop cutting rates and the RBA held things steady overnight. The BoJ cut JGB purchases on Tuesday, adding to the bear-steepening impetus.

Some are drawing parallels with the 2015 bund tantrum. “It is starting to smell a bit like the sell-off in the spring of 2015, but it is actually easier to put some factors behind it this time”, Bloomberg quotes Danske’s Arne Lohmann as saying. “Pricing is no longer for lower rates and momentum has shifted”.

Speaking of momentum, Nomura’s Charlie McElligott is out Tuesday reiterating an imminent inflection in the signals for key legacy longs in DM bonds (indeed, the model has already flipped for global bonds, and is on the verge of pivoting stateside).

“Global DM Bonds remain offered with curves continuing to (bear) steepen, as a number of tactical ‘reversal catalysts’ have converged to lean into the 2019 ‘Everything Duration’ trade”, Charlie wrote Tuesday, adding that the long-end selloff got an extra boost from the Financial Times story which suggested the Trump administration is looking at removing some tariffs in exchange for the signing of the “Phase One” trade deal.

McElligott continues, noting that the inflection he’s discussed at length lately is imminent. “Our CTA model’s anticipation of pending SIGNAL ‘FLIP’ TO SHORT (will go -29%) in both TY- and ED$- (ED4) positions remains firmly in place and set to turn tomorrow”, he says.

As a reminder, this is due to the 3m window (the largest weighting in the model) flipping short. The heavy weighting of that look-back tenor (nearly 65%) is enough to override the 1-year window, where the bullish bond trend is still intact.

(Nomura)

Notably, the model has already pivoted short for global developed market bonds. The signal is short for EUR 10Y, GBP 10Y, AUD 10Y, CAD 10Y, CHF 10Y, FRA 10Y and ESP 10Y – they’re all “-29% Short”, after being “+100% Long” for most of the year amid the duration infatuation.

(Nomura)

As ever, the positioning adjustments tipped by these trend follower signal flips are both a consequence of and a contributor to an ongoing shift in the market. That is, they are obviously a response to the underlying price action, but they can (and will) serve to exacerbate that same action.

McElligott goes on to reiterate some of the catalysts noted above.

“There are central bank catalysts in the form of the ongoing BOJ efforts to steepen the JGB curve, as well as increasing ‘Fed Pause’ narrative shift away from the heavily-positioned ‘Fed-cutting-to- Zero-in-a-year’ crowd”, he writes, adding that “the general ‘risk-ON'” theme continues to clash with (and effectively stop out) asymmetric positioning where investors had “herded-into ‘Long Worst-Case Scenario, Short Good News’ trades across the span of 2019”.

Starting mid-month in October, many of those “Long Worst-Case Scenario, Short Good News” expressions collided head-on with the positive vibes around the trade discussion as well as movement on Brexit. Now, the trade situation seems to be coalescing around a consensus that Trump will be forced to provide tariff relief and likely take the feared December 15 escalation off the table if he wants to cement the “Phase One” deal.

Needless to say, all of that has knock-on effects outside of rates. For instance, McElligott goes on to flag “tactical macro players reduc[ing] their Receiving exposure and re-risking into Equities and FX ‘high beta'”. (Note the offshore yuan strengthened back through 7 overnight.)

All of this raises several higher-level questions, not the least of which are: 1) What happens if positioning swings “too far” in the other direction over the course of the next couple of weeks only for Trump to decide, out of the blue, to rekindle the trade war in order to, for instance, engineer a December Fed cut, or 2) yields rise too far, too fast, an outcome which, over the past couple of years, has been difficult for record-high equities to digest with any degree of alacrity.


 

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