Behold! The Epic Treasury Short Covering This Week
Submitted by Tyler Durden on 05/30/2014 16:25 -0400
Charts: Bloomberg
It must be technicals, right? As we discussed here, there are numerous reasons for rates to be low and going lower but the world of talking-heads will have us all believe that this is simple positioning and the rally is 'short covering'. In the interests of helping to dismiss that myth, here is CFTC's 10Y Treasury Futures Total Shorts... showing the 'dramatic' short covering that occurred this week...
Charts: Bloomberg
Scotiabank Asks "Are Treasuries The Only Adult In The Room?"
Submitted by Tyler Durden on 05/29/2014 20:04 -0400
- For example, the US 10yr yield is 70 basis points higher than the French 10yr, while the US 5yr is only 6 basis points lower in yield than the Spanish 5yr. The Japanese 5yr and 10yr notes yields are 0.17% and 0.56%, respectively, compared to 1.49% and 2.42% (note: all comparisons are nominal yields).
I’ve also written about what Pimco calls the “New Neutral”. Basically, if the neutral nominal fed funds rate is closer to 2%, rather 4%, than Treasuries remain inexpensive.
It is possible that low global yields are a sign that expectations of future growth and inflation are falling. Several weeks ago, I wrote that maybe it was “time to reverse the causality”, where, “rather than assuming that stronger growth will bring higher yields, maybe investors should start asking whether exceptionally low global bond yields are saying something about the long-run state of the globalized economy and/or inflationary expectations (deflation)”.
- Many new headwinds have arisen in the form of Japan’s consumption tax, China’s attempts to reign-in its massive credit bubble, foreign central bank rate hikes, poor developed world demographics, globalization, Russian sanctions, and higher food and energy prices. There is also Fed policy where: QE= risk on. Ending QE = risk off.
There are several other factors that are unquantifiable, yet whose aspects are compelling enough to deter Treasury shorts and motivate others to cover underweights.
- The foremost factor is the markets persistent focus on a note that I wrote on March 28th about the changing incentives to corporate DB pension plans. I stated that rule changes will create strong demand for long end Treasuries causing them to trade with commodity like characteristics. I stated that the bottom line was, “The rule changes to the PBGC means that going forward, private DB plan managers will be driven less by their role as a fiduciary trying to ‘maximize return per unity of risk’, but rather by decisions based more by funding status and regulatory incentives that encourage LDI”.
- Chinese buying of US Treasuries is another compelling, yet unquantifiable, argument and possible source of demand. My colleague John Zawada first began discussing this topic last week with a similar story that printed in yesterday’s Financial Times. According to the Treasury Department, Chinese official holding fell by about $40 billion since last November, but ‘Belgium’ holdings increased by $200 billion. It is thought that a big foreign investor (China ?) has merely switched its custody service to Euroclear which is based in Brussels. The intentional devaluation of the Renminbi this year has resulted in a larger current account, so it makes sense that the ‘extra’ dollars would flow into Treasuries.
- The FT reported (via Wrightson ICAP analysis) that the drop in official Chinese holdings as a percentage of FX reserves fell from 37% to 32% since November. However, if you associate the increase in the ‘Belgium’ official holdings to China, then the percentage remains the same at 37%.
“If you’re always trying to be normal, you will never know how amazing you can be” – Maya Angelou
Via Scotiabank's Guy Haselmann,
Disparaged Treasuries are the Only Adult in the Room
Treasuries continue to do nothing wrong. My bullish views on bonds over the past several months have been met with stern opposition; however, several are now beginning to question their defiance. With such in mind, it is worth reviewing once again some possible explanations behind the bid. There are many reasons to expect their strong performance to continue (particularly over the next week). The bullets below are in no particular order.
The move below 2.5% in the 10-year has been accompanied with talk of convexity needs by mortgage servicers. Many expect a larger trigger below 2.3%, but the recent down in coupon trade is evidence of existing duration needs. However, it is only fair to point out that convexity flows are not what they used to be due to the rise in MBS holdings by the Fed, a decline in REIT holdings, and high premium MBS being mostly owned by the GSEs who now make fewer hedging adjustments than in the past.
A few shorter-term factors include tomorrow’s large month-end index extension of 0.12 years of the US Treasury Barclays Index and the fact that bond funds have registered their 11th consecutive week of inflows.
Looming over the market in the near-term is also next week’s ECB meeting where aggressive action is being anticipated due to well-telegraphed hints by Draghi. His hints have lowered yields and spreads across all European fixed income markets. Treasury (nominal) yields which have looked attractive relative to the rest of the world have been dragged even higher recently in sympathy with the move in European markets.
- For example, the US 10yr yield is 70 basis points higher than the French 10yr, while the US 5yr is only 6 basis points lower in yield than the Spanish 5yr. The Japanese 5yr and 10yr notes yields are 0.17% and 0.56%, respectively, compared to 1.49% and 2.42% (note: all comparisons are nominal yields).
I’ve also written about what Pimco calls the “New Neutral”. Basically, if the neutral nominal fed funds rate is closer to 2%, rather 4%, than Treasuries remain inexpensive.
It is possible that low global yields are a sign that expectations of future growth and inflation are falling. Several weeks ago, I wrote that maybe it was “time to reverse the causality”, where, “rather than assuming that stronger growth will bring higher yields, maybe investors should start asking whether exceptionally low global bond yields are saying something about the long-run state of the globalized economy and/or inflationary expectations (deflation)”.
- Many new headwinds have arisen in the form of Japan’s consumption tax, China’s attempts to reign-in its massive credit bubble, foreign central bank rate hikes, poor developed world demographics, globalization, Russian sanctions, and higher food and energy prices. There is also Fed policy where: QE= risk on. Ending QE = risk off.
There are several other factors that are unquantifiable, yet whose aspects are compelling enough to deter Treasury shorts and motivate others to cover underweights.
- The foremost factor is the markets persistent focus on a note that I wrote on March 28th about the changing incentives to corporate DB pension plans. I stated that rule changes will create strong demand for long end Treasuries causing them to trade with commodity like characteristics. I stated that the bottom line was, “The rule changes to the PBGC means that going forward, private DB plan managers will be driven less by their role as a fiduciary trying to ‘maximize return per unity of risk’, but rather by decisions based more by funding status and regulatory incentives that encourage LDI”.
- Chinese buying of US Treasuries is another compelling, yet unquantifiable, argument and possible source of demand. My colleague John Zawada first began discussing this topic last week with a similar story that printed in yesterday’s Financial Times. According to the Treasury Department, Chinese official holding fell by about $40 billion since last November, but ‘Belgium’ holdings increased by $200 billion. It is thought that a big foreign investor (China ?) has merely switched its custody service to Euroclear which is based in Brussels. The intentional devaluation of the Renminbi this year has resulted in a larger current account, so it makes sense that the ‘extra’ dollars would flow into Treasuries.
- The FT reported (via Wrightson ICAP analysis) that the drop in official Chinese holdings as a percentage of FX reserves fell from 37% to 32% since November. However, if you associate the increase in the ‘Belgium’ official holdings to China, then the percentage remains the same at 37%.
“If you’re always trying to be normal, you will never know how amazing you can be” – Maya Angelou
As Primary Dealers And Banks Bash Treasurys, Here Is What They Are Really Doing
While stocks continue to levitate to record highs day after day in a market where selling is seemingly prohibited, there remains one major fly in the ointment - the same fly that as we described yesterday has managed to "paralyze" asset managers - namely plunging bond yields, i.e. surging bond prices, both in the US and in Europe. The problem is that since stocks are supposedly "pricing in" a recovery, it makes no sense that bonds are concurrently pricing in accelerating deflation and a global economic slowdown.
This is further compounded by the fact that all major banks are, at least superficially, extremely bearish on bonds: at the beginning of the year, when the 10Y had just hit 3.0%, there was barely a sellside research report that expected the 10 Year to be below 3.5% in 2014, let alone touch 2.4% as it did today.
This is a glaring disconnect and is the reason why pundit after pundit on CNBC is screaming to ignore bonds, and better yet, sell or short them (ignoring record short interest and the ongoing squeeze), while focusing only on stocks, also ignoring that in several decades of market history bonds always end up right compared to stocks (then again, this is "market" history, not the centrally-planned, New Normal Greenspan-Bernanke-Yellen Frankenstein monster market) sooner or later.
But going back to the question about this same "smartest money" which in report after report can't find bad enough words to say about bonds, is there more here than meets the eye.
As it turns out yet.
A quick look at the Fed's Primary Dealer database shows that while banks have been actively dumping their holdings in the near-belly end of the curve, namely paper in the 3-6 year range, they have been buying up bonds in the 11 year + maturity bucket.
As the chart below shows, while Dealer holdings of bonds in the 3 - 6 Year bucket are down to -$12.6 billion as of the latest week of May 16, or the lowest position since June 2011, they have just taken their holdings in the 11Y+ long end to $11.9 billion: the most long they have been in the farthest part of the curve since June of 2013.
So if one were to net these two buckets out, by subtracting net exposure in the 3-6 Year bucket from the 11 Year bucket, one would see just how "flat" or "steep" dealers are positioned. The result is shown below: it shows that a rough estimation of curve positioning has Primary Dealers positioned for the flattest bond market (long the long end, short the short end) the most since November 2011 when, as many will recall, Europe was on the verge of complete collapse and only yet another Fed-backed global bailout prevented the all out disintegration of the Eurozone!
Bottom line: while dealers are telling their clients to dump the long end immediately due to everyone mispricing economic growth and inflation prospects, and to expect the long awaited curve steepening any minute now, what are they doing?They are the flattest they have been in two and a half years! In other words, buying.
And one other observation: if one expands the universe of bond holders from just Primary Dealers to all commercial banks operating in the US (as reported by the Fed's weekly H.8 statement), what does one get?
One gets the following total Treasury exposure. It needs no explanation.
10Y Treasury Yield Hits 2.40%
It seems shorts keep covering and the Chinese keep buying (through Belgium of course - as they sell CNY, buy USD, and grab the extra yield on Treasuries). Despite stocks relative stability, 10Y yields have just hit 2.40% for the first time in over 11 months (as USDJPY broke down). It seems this morning's dismal GDP print was just enough to confirm the growth/inflation slowing meme (in bond investors' minds) and the yield curve is flattening even further...
10Y at 11 month lows at 2.40%
Led by USDJPY
As the divergence grows...
Why are they buying Treasuries? because they offer great yield pick up - unbelievably...
Charts: Bloomberg
http://www.bloomberg.com/news/2014-05-29/treasury-gain-pushes-yield-to-lowest-versus-peers-in-8-months.html
Bond Surge Worldwide Drives Index Yield to One-Year Low
A worldwide bond-market surge pushed yields to the lowest levels in a year on growing evidence central banks can keep stimulating economic growth without igniting inflation.
Treasury 10-year note yields fell to the least since June. A rally yesterday drove the yield on the Bloomberg Global Developed Sovereign Bond Index to 1.28 percent, the lowest since May 2013. Australia’s (GACGB10) 10-year yield dropped to an 11-month low, Japan’s slid to the least in 12 months, while European bond yields were close to the lowest since the formation of the region’s shared currency. The U.S. sold $29 billion of seven-year notes at the lowest yield since October.
The U.S. economy contracted 1 percent in the first quarter, the Commerce Department said. Fixed-income securities rallied yesterday in the wake of a report showing German unemployment unexpectedly rose in May.
“It gives investors less fear about what’s going on with the U.S. and more with what’s happening globally,” said Aaron Kohli, an interest-rate strategist BNP Paribas SA in New York, one of 22 primary dealers that trade with the Federal Reserve. “The fundamentals are not in favor of what’s going on in rates, but it’s something that can go on for much longer because the momentum is so strong.”
The Bloomberg Global Developed Sovereign Bond index has climbed 4.3 percent this year through yesterday, while Treasuries (BUSY) returned 3.6 percent, based on Bloomberg indexes. Every one of the 26 bond markets from Hungary to Japan tracked by Bloomberg and the European Federation of Financial Analysts Societies has gained during the past month.
Treasury Yields
The benchmark U.S. 10-year yield dropped as much as four basis points, or 0.04 percentage point, to 2.40 percent, the lowest since June 21, before trading at 2.46 percent at 3:47 p.m. New York time, Bloomberg Bond Trader data showed. The yield fell seven basis points yesterday. The price of the 2.5 percent note due in May 2024 slipped 3/32, or 94 cents per $1,000 face amount, to 100 13/32.
Australia’s 10-year yield lost as much as nine basis points to 3.61 percent. Japan’s dropped to as low as 0.56 percent. Singapore’s fell to 2.18 percent, the lowest level since October.
Evidence that weakening labor markets will constrain demand and inflation has caused investors to pour into government bonds. That’s confounded economist predictions for a second year of losses as signs earlier this year that U.S. economic growth is gaining traction prompted theFederal Reserve to taper its $85 billion-a-month bond-buying program.
Auction Yield
The Treasury’s auction of seven-year notes today drew a yield of 2.010 percent. The bid-to-coverratio, which gauges demand by comparing the amount of bids with the amount of debt, was 2.60, versus an average of 2.55 at the past 10 auctions. Yields at a five-year note sale yesterday dropped to the lowest since November.
“It’s a good, old-fashioned squeeze” as investors who bet on lower prices for Treasuries have been forced to buy them as the debt rallied, said David Ader, head of U.S. government bond strategy at CRT Capital Group LLC in Stamford, Connecticut. “We are pretty close to the bottom in yields for the year.”
It was the final of three sales this week of coupon-bearing notes. The $35 billion of five-year securities sold yesterday at a yield of 1.513 percent and $31 billion of two-year debt auctioned on May 27 drew a yield of 0.392 percent.
ECB MEETING
Euro-area government bonds have advanced since European Central Bank President Mario Draghi said on May 8 the Governing Council was “comfortable” taking measures to boost inflation in the region. Consumer-price increases in the 18-nation currency bloc have been less than half the central bank’s goal of below 2 percent since October. The ECB meets on June 5.
An estimate due June 3 will show the rate was at 0.7 percent for a second month in May, according to the median forecast of economists surveyed by Bloomberg.
“You have a dynamic today that is at play that I’d say is truly extraordinary, and I’d argue is truly historic, where Draghi and ECB are going to be incredibly aggressive going forward,” BlackRock Inc.’s chief investment officer Rick Rieder said in a television interview on “Bloomberg Surveillance” with Tom Keene. “U.S. Treasuries don’t look that bad, relative to the rest of the world.”
Inflation Gauge
The Fed’s preferred gauge of inflation, an index of personal consumption expenditures, has remained below its 2 percent target for almost two years. The measure increased 1.1 percent in March, the latest figure available, from a year earlier.
The average yield to maturity on bonds from Greece, Ireland, Italy, Portugal and Spain fell to 2.13 percent yesterday, matching the least since the formation of the currency bloc in 1999, according to Bank of America Merrill Lynch indexes.
Greece’s government securities returned 26 percent this year through yesterday and Portugal’s increased 15 percent, the best-performing sovereign debt markets tracked by Bloomberg World Bond Indexes. Treasuries gained 3.6 percent and German bonds earned 4.4 percent.
“I would be surprised if we rallied a lot from here, but it can always happen,” said Justin Lederer, an interest rate strategist at Cantor Fitzgerald LP in New York, one of 22 primary dealers that trade with the Fed. “I look at the these peripherals and am totally surprised that Italy and Spain could be trading at sub-3 percent given where we were two years ago when everything was breaking up inEurope.”
U.S. government securities maturing in 10 years and longer yielded 92 basis points more than non-U.S. sovereign debt, the lowest level since Sept. 25, Bank of America Merrill Lynch indexes showed.
The International Monetary Fund last month predicted global growth of 3.6 percent in 2014, revising down its January estimate of 3.7 percent. Next year, the expansion will accelerate to 3.9 percent, unchanged from the prior forecast.
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