“Duration simply has no friends until the US data rolls over,” Nomura’s Charlie McElligott said earlier this week.
The data isn’t rolling over. So duration still has no friends.
Both ISM manufacturing and the JOLTS update were amenable to a hawkish interpretation. Yes, the US factory sector spent an 11th month in contraction in September, and yes, Americans seem to be a little more cautious about quitting their jobs than they were during “peak worker scarcity,” but ISM is one good month away from expansion territory and the headline job openings print was a massive beat that underscored the ongoing labor supply-demand imbalance that’s contributing to elevated wage growth.
Between the data, a steady stream of “rates can go higher” commentary from the biggest names in the financial universe (including Jamie Dimon and Ray Dalio) and, perhaps most importantly, stressed out longs inclined to capitulate and shorts letting it ride, the bear steepener extended on Tuesday in the US, when 30-year yields pushed through 2010 levels.
Long-bond yields were cheaper by 15bps, and are now 100bps higher over just three months.
Momentum chasing is almost surely in play now. “Flows reflected the pain of a further down trade with mostly systematic trading following momentum while real money is absent in New York trading,” Bloomberg’s Alyce Andres remarked, noting that CTAs sold 30-year contracts during the London session.
It certainly doesn’t help that discretionary investors (i.e., humans) spent a good part of 2023 buying bonds on the excuse that yields are elevated and capital appreciation is all but guaranteed in the medium-term given the allegedly high odds of a recession, the likely end to the Fed’s hiking cycle and the simple fact that US government bonds have never logged three consecutive years of losses. Those longs are underwater. As Andres put it, “longs feel more pain than shorts resulting in the market being more sensitive to bearish news than to bullish factors.”
At the same time, Treasury funds are on track for a record year of inflows. There are two important takeaways from that factoid. First, yields are rising despite those inflows. Second, those ostensible dip-buyers are getting burned over and over again. How long before they tire of that?
“Persistent inflows into bond funds has seen active US bond mutual funds exhibit an elevated total duration beta [or] an above average sensitivity of returns to US Agg returns, indicating overweights,” JPMorgan’s Nikolaos Panigirtzoglou noted late last week, while explaining why the bear steepener “might not be behind us.” “When we look at monthly returns of these active bond funds as well as components of the US Agg index, they appear to have shifted from credit overweights in July to overweights in USTs more recently,” he added.
Panigirtzoglou went on to note that the banking system “continues to shed duration.” “US commercial banks have continued to sell bonds at a pace of just under $100 billion per quarter in Q2 and Q3,” he said. “Given still-elevated bond shares on US banks’ balance sheets, it appears likely this selling pressure will continue in coming quarters [while] FX reserve managers appear to have turned to selling bonds in Q3.”
The reserve manager point is difficult to pin down. I’m no Brad Setser, but inexorable dollar strength does raise the odds of foreign intervention on the margins. That’s a “hypothetical incremental ‘supply’ risk,” as McElligott put it, and it comes atop the pervasive, deficit-related supply concerns already weighing on the US long-end.
10-year yields breached 4.75% with ease on Tuesday, sharply steepening the 2s10s with the short-end stuck in “wait and see” mode ahead of this year’s final two FOMC meetings. 10-year yields were above five-year yields.
This is, to put it bluntly, a falling knife. I’m inclined to catch it. Or try to catch it. I’m not your fiduciary, though. Consult your financial advisor. Not investment advice. And every, single other caveat that may apply.
What I can safely say, with something approaching confidence, is that 10s are oversold. And yields are cheap to fair value too. But, that doesn’t guarantee a rally, something BMO’s Ian Lyngen and Ben Jeffery emphasized.
“While we remain constructive on Treasurys in the medium-term, the momentum behind the selloff has left us willing to go-with the move; or at a minimum, refrain from attempting to call the peak in yields,” they wrote. “The technicals indicate that the move is overdue for a bullish reversal or an extended period of consolidation [but] stochastics and MACD can be at the extremes for a while before the reversal implications are realized.”
