Quite a few adjectives were trotted out to describe Thursday’s duration rally, with “counterintuitive” serving as the go-to.
How can it be, folks wondered, that bonds not only refuse to extend Q1’s losses, but in fact demonstrate a predisposition to rally in the face of rip-roaring US economic data?
Thursday’s rally and accompanying bull flattening impulse felt just as inevitable as it did illogical. That sounds like a paradox, but as I put it in “Raising Eyebrows,” 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 was perhaps only fitting that bonds’ disposition to rally crescendoed on a day when retail sales and jobless claims both printed massive beats.
On Friday, Nomura’s Charlie McElligott cited a trio of factors to explain the “escalation,” which he noted “has acted to further accelerate the rather dramatic countertrend reversal seen MTD in Equities thematics / risk premia.”
First, he pointed to seasonality in April, calling that “a known phenomenon,” and elaborating on some of the same dynamics discussed here on Thursday and at various intervals earlier this week. “A large part of this… is the new Japanese fiscal year commencing,” Charlie said, noting that “‘captive’ buyers of bonds are loading back into foreign fixed-income, particularly if on [an] FX-hedged basis.”
Second, he cited a “domestic buy flow,” particularly receiving in the belly, evidence of pension de-risking into fixed income and buying from bank portfolios “as loan growth remains ‘meh.'” As an aside, anecdotes from banks about ‘meh’ loan growth served as damper on sentiment this week as earnings rolled out.
Finally, McElligott said that “a lot of this is simply about stop-outs in profitable-yet-crowded shorts and steepeners.” He pointed specifically to CTAs, where the bank’s model “shows the aggregate notional $ ‘short’ in G10 Bonds is -3SD dating back to 2010.”
Commenting Thursday afternoon in a colorful and characteristically eloquent piece, BMO’s Ian Lyngen and Ben Jeffery offered what they called “the five stages of reflationist grieving.” The first is “price action denial,” when traders say “this must just be short-covering by weak hands.”
Lyngen then delineated the next four stages as follows (and I’m quoting directly from him in the bullet points below),
- directional angst – the market has got this all wrong again – look at the core-CPI data from March and the roaring retail sales,
- positional depression – well, at least it’s not a crypto short – is it?
- retracement bargaining – if 10-year yields can just retest 1.75% there would be a short reload, and
- rally acceptance – colloquially known as capitulation
So, where does that leave us?
Well, you can write your own script — I always encourage folks to “choose their own adventure,” both in markets and in life.
For his part, Lyngen suggested that “the rates market is in the midst of a capitulation” that might see 10-year yields through 1.50%.
McElligott on Friday wrote that “this recent bout of UST bull flattening is largely a function of profit-taking and unwinds of crowded shorts and steepener positions, and as such, will likely see redeployment at ‘better levels’ now that positioning is much cleaner.”