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Curve Fireworks Continue With Wholesale Flattening Following Steepener Capitulation Overnight
After surging to a several week high, the 2s10s has plummeted to a one week low in the matter of hours, dropping back down to 236 bps. This follows a day of fireworks in the curve, in which as Market News discusses below, we saw some pretty aggressive hysteria in flattener unwinds. Oddly enough, the collapse in the curve has occurred as the 2s have hit another record low yield, indicating that no matter how much of a spin opportunity any given diffusion index headline provides, the bond market is increasingly pricing in deflation (and in fact the yield on various classes of TIPS was negative earlier today).
For Market News' Talk from the Trenches summary on the moves int he curve below, read on:
Over the last two days, the 5-year/30-year Treasury curve has steepened about 16 basis points and many players that were involved with the flattening trade got crushed.
Remember that this market has had a flattening bias for a very long time given the premise that the Federal Reserve will be on hold for a long, long time. Therefore, in order to earn returns, people have been relying on the carry trade: in other words, borrow short and invest long to earn the spread.
The trade is clearly overpopulated and it only took a few trades in the opposite direction to send these players into a tizzy. When prices went against them, they bailed.
The move began Wednesday when the 5-year auction received stellar demand. A prominent bond fund and a large central bank were believed to have bought. Soon flattening trades were being unwound and the prominent bond fund advocated the buying of 5-year notes.
Steepening trades ensued, sending the curve even steeper. Many black box accounts also had to bail.Then on Thursday, a large hedge fund was said to have unwound a large flattener and the steepening continued.
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PIMPco
Could that possibly be our friends at Pimpco and the Fed? Sounds like a 70's or 80's easy rock band or maybe a 90's boy band.
And now boys and girls, we're pleased to bring you the fabulously talented "Pimpco and the Feds". Give them a nice round of applause.
Q: What happens to yields if deflation is quite virulent? If they go negative does that mean you get less than your principal back? If the purchasing power of cash increases during deflation while bond yields go negative doesn't that spell the doom of bond markets until things hit bottom, half the population of the Earth gets wiped out in the frenzy and some form of growth resumes as the phoenix of new and improved capitalism rises from the ashes?
What happens to gold?
ORI
http://aadivaahan.wordpress.com
It takes off the steepener trades or it gets the hose again
Logic tells you that a state with as big a budget mess as California should be paying the price in higher interest rates when it comes to the bonds its issues.
But in this case, logic is wrong. As Tom Petruno writes in the Los Angeles Times, the annualized tax-free yield on California's five-year general-obligation bonds has fallen to 2.1% from 3% in mid April. That compares with 4% in mid 2009. And it's despite California's budget impasse.
California bonds are simply benefitting from investors' disgust with the lackluster stock market, fears about the overall economy, and desire to have some kind of return for their cash.
A widespread belief taxes will rise next year makes tax-free bonds look even better. Budget-tightening by states and municipalities around the city mean fewer bonds are being issued, so supply and demand comes into play too.
Even if California starts paying bills with IOUs again, as the state controller is threatening, bond investors can breath easy. Part of the reason is to make sure the state has hoarded enough money to pay its bondholders. Take that, furloughed California workers.
GBPUSD upside continues, since daily and weekly charts remain bullish.
http://stockmarket618.wordpress.com/about
This is when you want to buy TIPS of course, under normal circumstances they would trade at a discount to par, unless the Fed continues to front run.
Why would the yield on inflation-linked bonds be trading negative if the bond market is predicting deflation?
Perhaps you mean the "breakeven inflation rate" was negative, which is the yield on the nominal bond minus the yield on the inflation-linked bond.
So people should be selling the linker, not buying it (as you would have them to do to send the yield negative).
Good question. I think the smart money believes deflation s-t, and inflation l-t. Since investors will accept lower yields to profit from this inflation, they most likely have longer time horizons.
BTW, March 2008 also had TIPS going neg.
Actually it was more a rhetorical question....I was telling the author he got it around the wrong way. The yield on TIPS is not and has not been negative.
The breakeven inflation rate has been negative in the past (implying deflation) and I'm guessing it has gone negative again recently.
A negative real yield and negative BE are very different things, in one case you want to own the linker, in the other you want to be short.
Capitulation, snitches!