Raising Eyebrows

Thursday was something of a barnburner for multi-asset investors.

After suffering an egregious first quarter rout, bonds have been reluctant to sell off this month despite mounting evidence that the US economy is indeed poised to realize the kind of blockbuster growth consensus expects going forward.

Given the counterintuitive character of the market in April (i.e., bonds exhibiting signs of resilience in the face of scorching US data and outperformance from secular growth and other equities expressions that lost out in the post-election, pro-cyclical euphoria), it’s perhaps only fitting that bonds’ disposition to rally crescendoed on a day when retail sales and jobless claims both printed massive beats.

Yields fell by as much as 12bps out the curve, as the bull flattening impulse gathered steam in what Bloomberg’s Edward Bolingbroke called an eyebrow-raising move. “We’ve seen some real-money cash buying emerge which would support further gains, while an expected influx of bank issuance deals may also be providing favorable hedging flows, all against the backdrop of an expected pick-up in demand from Japanese accounts,” he said Thursday, adding that “the rally may be signaling a separate wave of short covering flows as the outlook turns more favorable for bonds.”

The 2s10s flattened the most since November. TLT, the widely-followed long-end product which fell into a bear market on March 12, managed its second best session of 2021 (figure below).

Through Thursday afternoon, the vehicle was on track to log its best week of an otherwise abysmal year.

“Our constructive bias has been further reinforced by the weekly MoF data that revealed during the week of April 9 Japanese investors bought $15.6 billion in overseas notes and bonds,” BMO’s Ian Lyngen and Ben Jeffery said. “This series includes all non-Japanese sovereign debt [but] the vast majority of it tends to be US Treasurys [and] given the hedged-to-yen yield in this current environment, the attractiveness of US rates hedged back into local currency remains an important backdrop in pondering which investor bases will participate in the ever-growing net issuance requirement,” they added.

As bonds surged, so too did US equities. The S&P hit a new record high, with tech and healthcare leading the charge. I wanted to overcomplicate this — I really, really did. As regular readers can attest, if it’s possible to overcomplicate something, I’m ready and willing to engage in any and all efforts to reinvent the wheel. But on Thursday, simply owning SPY and TLT was as good a strategy as any.

If you’re looking for definitive answers on the Treasury rally in the face of rip-roaring US economic data, don’t ask State Street. “This continues to be one of the more confusing dynamics in markets at least right now,” Michael Arone, chief investment strategist for the firm’s SPDR exchange-traded business told Bloomberg.

Commodities were higher Thursday too. Gold rose sharply. If you lost money, you must have been trying.

TD’s Priya Misra said Wednesday that “Japanese inflows into foreign bond markets typically start to pick up in May and tend to peak in July, August and September.” “This buying pattern of Japanese investors coincides with the seasonally strong performance of global sovereign bonds in the summer,” she remarked.

Of course, it probably helps that Fed officials have gone out of their way (and then some) to make it clear that if there were plans to taper asset purchases, you’d know about them.

The absurdly recursive nature of forward guidance means that any indication that the Fed is considering whether and when to taper will be treated as though it were the taper announcement itself. As such, it’s not just the actual taper that needs to be telegraphed well in advance, but also the discussion about tapering, and perhaps even the discussion about having the discussion.

So, while the Fed may be fine with a backup in long-end yields to the extent it can be pitched as a sign of confidence in the US recovery, I’d still submit that an eventual WAM extension or a new Operation Twist are just as likely as not.