Bon(d)fire

An already tough day for bonds was made worse by a 30-year sale that “boasted” the biggest tail in a decade.

The auction stopped at 1.94%, tailing more than 5bps and conjuring the ghost of February’s disastrous seven-year sale. On the face of it, it was an extremely ugly result, and it rippled across markets, sending equities to session lows.

The poor showing came hours after October’s inflation data came in scorching-hot, casting more doubt on the widely maligned “transitory” characterization of price pressures stateside.

30-year yields had fallen near the lowest levels of the year headed into Wednesday, as markets appeared to price a growth scare, a policy mistake or some combination of the two. 30-year real yields hit a record low earlier this week.

Following the auction, long bond yields jumped as much as 14bps, re-steepening the 5s30s, which had flattened further after tightening to ~75bps over the past several days (figure below). Some of the knee-jerk reaction in the long-end was subsequently unwound.

At one point, the 5s30s sat at 65bps. The belly is where the pressure will show barring an inflation print bad enough to suggest the Fed has totally lost control.

Wednesday was set to be among the worst days of 2021 for the popular Treasury ETF (figure below).

It appears rates will continue to whipsaw following the fireworks witnessed late last month. “It seems to me that the market is going to take another shot at ‘short Rates / Bonds’ soon,” Nomura’s Charlie McElligott said Wednesday, just prior to the CPI print. “From a sequencing perspective, I think we can actually begin a nascent bear-steepening again soon if today’s inflation data opens the door to even larger prints thereafter, which would obviously run contra to all this flattening which has been put on,” he added.

Of course, if we do see inflation continue to run even hotter than the elevated readings the market already expects, traders could start to again price in preemptive action from central banks, who spent the first week of November trying to talk back the very same rate hike expectations they countenanced for most of October. That, in turn, could lead to another dramatic bear flattener and more short-end drama, in yet another reversal.

This has been a dizzying ride for some. Investors were max bearish bonds last month, only to get wrong-footed.

“There has been a fair amount of disagreement around precisely what triggered the extension of the post-FOMC rally,” BMO’s Ian Lyngen and Ben Jeffery said. “We’re content with the combination of the Brainard chatter, Taiwan Strait tensions, and short-covering needs; however, there is a meaningful risk that the positions angle is the most significant influence as expectations for 2022 come into focus and a tamer pace of the recovery has become the consensus forecast.”

The reversal was particularly dramatic for CTAs. “Net exposure across all G10 Bond futs just two weeks ago was as close to historically ‘max short’ as we’d seen in 10 years but is now nearly neutral in aggregate after massive notional short-covering and outright buying over the past two+ weeks,” McElligott went on to say. On Nomura’s model, CTAs added more than $140 billion of net exposure.

The figure (above, from Nomura) illustrates the whipsaw for CTA trend.

Equities largely ignored last month’s chaos in rates, and I suppose it’s possible they’ll do the same should things get messy again, but as BofA noted last week, equity duration is near a record at ~35 years.

“A 1ppt increase in the cost of equity could drive the S&P 500 to ~3600,” Savita Subramanian cautioned.

Obviously, big-cap tech is extremely vulnerable. The Nasdaq 100 tumbled Wednesday following the ugly 30-year sale.

“The biggest sell program since October 6 rolled through stocks today at 1:04 p.m. NYT,” Bloomberg’s Alyce Andres observed. “Sell programs larger than 1,000 names have been increasingly evident in recent days and it’s flow that bears watching.”