Is Today's Bond Selloff Driven By Goldman's Announcement 2.50% Target On 10 Year Reached

Tyler Durden's picture

While there is nothing to suggest a fundamental improvement in the economy, and judging by the latest batch of data the economy is in fact continuing to deteriorate, we have so far seen a substantial sell off in bonds across the curve, with the 2s10s steepening by 11 bps (just in time for the bull flattener bandwagon to enjoy some out-of-steepener rotation pain). So what is the catalyst for the selloff? Francesco Garzarelli's note to Goldman clients titled "Forecast Reached, Risks Now Balanced", in which he implicitly advises to take profits on USTs, sent earlier may provide some clues...

Forecast Reached, Risks Now Balanced August 27, 2010

1. The intervening weeks between this and the previous edition of the Bond Snapshot on August 6 have seen the release of weaker-than-expected US economic data, validating the view that the second half slowdown that we have long expected is now upon us. Government bond total returns over this period have ranged between 0.9% in Japan and 2.9% in Australia.

2. US 10-yr Treasuries are now bouncing around our revised 3-month forecast of 2.5%. The rally was driven by flows into the very long end of the yield curve, with 30-yr yields falling by around 40bp to just above 3.5%. This bull flattening of the US yield curve has prompted similar behaviour in other G-10 yield curves and further afield in EM rates markets, as the search for yield in these other markets has pushed rates to fresh lows. The sharp move in 10-yr German Bund yields towards 2% is notable, as is the rally in intermediate UK Gilts.

3. There are two important issues worth highlighting at this juncture. First, the macroeconomic conditions accompanying the rally in fixed income are very different to those that saw yields reach similarly low levels at the height of the financial crisis. While recession fears were a clear driver at the time, the price action was further augmented by substantial ‘flight-to-quality’ flows emanating from the broad liquidation of risky assets. Although the risk of a ‘double-dip’ recession has increased, our Financial Stress Index shows ongoing normalisation in credit intermediation, lending standards are easing, and overall financial conditions loosening.

4. Second, we are still observing a healthier growth momentum outside the US, and notably in Europe and the emerging markets. This is in sharp contrast to the situation in late 2008, when macro spillovers from the credit crisis were as harsh outside the US as inside. The relative strength of non-US growth (as we and the consensus forecast) is the basis on which our valuation model argues that bonds have become moderately ‘rich’ (1 standard deviation in 10-yr US Treasuries). It is important to recognise, however, that current yield levels are not suggestive of a bond bubble, as some commentators have stated. Using 10-yr Treasuries as a gauge and based on our current economic projections, yields would be deeply overvalued only from 2.25% and below.

5. With these considerations in mind, we believe that the risks to 10-yr UST yields are symmetric around current levels, as they already incorporate our below-consensus views on US growth, and our view that policy rates will end up above the forwards in Europe next year. On our baseline case, yields are unchanged over the next three months, and rise over the next 6 months. The F.I. Snippets from August 13, ‘Growth Holds the Key’, elaborates on these points and sets out in more detail the forces at play which should keep USTs on the knife edge of our 3-month forecast: looser financial conditions, US growth recovery from Q2 21011 and a depressed global bond premium.

6. The rally has also filtered through to Inflation markets, particularly in the US, which has shown the largest downward correction in inflation expectations, with 5-yr inflations swaps shifting down by just under 30bp to around 1.4%. USD swaps are now pricing CPI inflation running at a meagre 50bp over the next year (August 2010 to August 2011).

7. In Europe, 5-yr inflation swaps have also fallen, but to a lesser extent given the very depressed starting point. In the UK, the sell-off has been less pronounced, with less than a 10bp drop. On our view, the UK RPI curve is the most vulnerable inflation market in the G3. We remain bearish on UK inflation (i.e., we expect inflation to print lower than what is reflected in the forwards). Our recommended short 5-yr UK real rates trade hit the stop-loss, as the nominal swap leg of the trade suffered from the general rally in G3 rates, even though UK inflation expectations are drifting lower.

8. Returning to the long end of the yield curve, the correction has been amplified by asset-liability management flows (a tell-tale sign is the behaviour of swap spreads), particularly at the 30-yr maturity in the US. Our calculations suggest that, since the end of last year, defined benefit private pension plan solvency ratios have been deteriorating at a faster pace in the Euro-area (a –22% decline in solvency position) than in the United States (–14%). The absolute levels of aggregate solvency are hard to pin down, primarily because there is no information available on the derivatives overlay. In the US, we would put solvency today broadly at the same level as in July 2009 (and briefly at the end of June 2010, when the S&P touched 1020). Meanwhile, in Holland and Germany combined, the solvency position is at its worst position since March 2009. Interestingly, the UK plans seem to be in a comparatively better position. Again, these estimates should be taken with a pinch of salt, because they are aggregations of possibly very different positions in very different types of plans.

9. Fed Chairman Bernanke speaks today at the Fed’s annual retreat in Jackson Hole, Wyoming at 10:00am EDT. The recent split in the FOMC over reinvestment of the debt principal suggests that the Fed Chairman is likely to be more backward-looking than he might otherwise have been, providing an overview of economic risks going forward rather than elaborating in greater detail on future policy moves. Next week sees a large amount of other important news items in the US, which is likely to move markets: the minutes of the FOMC meeting (which could provide insight on the recent discussions recently), consumption data, the PMI, ADP employment, core PCE inflation, the ISM surveys and the all-important Non-farm payroll number for August. In the UK, we will see data on consumer borrowing, while in the Euro-zone several of the figures for the core countries and overall Euro-zone on consumer confidence, unemployment, CPI and most importantly, PMIs, are set to be released. The ECB is also meeting next week on Sep 2, and we continue to expect no changes to monetary policy.

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Steak's picture

i do hope i'm not imposing here :)

A yin and a yang

limit down (a bassy and moody playlist): 

down the boulevard (a stroll down the way playlist): 

Number 156's picture

Next week sees a large amount of other important news items in the US, which is likely to move markets.... consumption data, the PMI, core PCE inflation, the ISM surveys .. Non-farm payroll number for August ..

The the Fed is indeed running out of bullets, other than this: Fake data.

I think we will see more and more massaging and revising of the numbers presented to us as this would be within their control. Don't immediately believe what comes out of their offices.

Cognitive Dissonance's picture

The the Fed is indeed running out of bullets, other than this: Fake data.

Fake data has long been a staple of the Ponzi.

I see something else interesting happening lately. While for the past the band has been led by the Fed, the Fed has signaled that "private business" and "governmental policy" should take over. However, it appears what that really means is that private business can take the lead in the Ponzi dance and government can enable the lead with "accommodative policy".

For the layman, this means that the out-of-bullets Fed has just told everyone else that if "you guys want some more to eat, you're going to need to feed yourself". Phase two of the Ponzi is kicking in gear. This is a prime example of self interest among a wide and diverse group of people doesn't need specific instructions or overt control mechanisms in order to act conspiratorially. 

Number 156's picture


I agree. That is a really great observation worthy of its own thread.


MachoMan's picture

This is a prime example of self interest among a wide and diverse group of people doesn't need specific instructions or overt control mechanisms in order to act conspiratorially.

The school of fish may swim the same direction, but that doesn't mean they've agreed to be in a conspiracy together.  We're all free to dissect the available information and act accordingly...  if you're capable of making the observation and acting upon it, in pursuit of the maximization of your self interest, does that make you a co-conspirator?  What about the people carrying out the actions without notice of the conspiracy?  Are they culpable as co-conspirators?

In order to have a fruitful solution, we have to attack the prevalent incentives that drive the actors, not any purported conspiracy amongst them. 

Cognitive Dissonance's picture

Let me repeat my statement. I'm talking about subtlety here.

This is a prime example of self interest among a wide and diverse group of people doesn't need specific instructions or overt control mechanisms in order to act conspiratorially.

So I agree, it doesn't mean they've agreed to be in a conspiracy together. That's what I meant when I said "doesn't need specific instructions or overt control mechanisms". I'm saying their self interest aligns them to act in concert without a control center or overt and deliberate control.

I think people are so caught up in the word "conspiracy" that they've never taken the time to recognize how it's used in the justice system. There are too numerous to count examples of silent or implied conspiracies that are just as successful at achieving their goals without a word spoken.

The thing is that we call those methods different things, such as a "culture of corruption" or "an unspoken rule to screw the customer" and so on. 

BTW cutting edge research is beginning to show that the school of fish you reference is actually communicating. Only it's happening on a different level than you or I am tuned to. In many cases, the fish are reacting faster than their own senses can process outside information. Which means something else is going on here.

MachoMan's picture

Actually, as an attorney, I'm perfectly aware of how it is used in the justice system.  In order to act as part of a conspiracy, you need to have an agreement...  if the FED sends smoke signals to everyone, and I act based upon my subjective interpretation, this is not a conspiracy.  It may entail similar action from many other actors that appears to be in concert...  but, by definition, it is not a conspiracy.  An "unspoken rule" is not a conspiracy either...

I really do not think the allegations would pass a motion to dismiss based upon the standard presented in this case (see section IV):   

Cognitive Dissonance's picture

Sir, are you saying that something isn't real unless it can be prosecuted using the rules if evidence that favors people with money? That we shouldn't consider something unless charges can be brought? Are you that caught in the consensus reality that you can't see outside it? 


MachoMan's picture

I'm saying that by definition, it is not a conspiracy without an agreement.  There is no agreement.  There is simply aligned self interest.  If coincidental self interest amounts to a conspiracy, then we're all co-conspirators to extract and utilize the earth's oxygen and water.  A conspiracy is vastly more narrow...  and much better defined. 

I agree that there is contemporaneous self interest that appears to be in concert...  on an incredible amount of fronts...  that is irrefutable (you don't have to believe in the theory of gravity to believe your feet stick to the ground).  What is questionable is the degree to which the actors or co-conspirators have agreed to act in cooperation, to the same end.  That is the leap of faith we are expected to make.

Robslob's picture

I would add NEVER believe what comes out of their offices...and compare their mouths to fecal matter of PIGS

Number 156's picture

There's lots of data that they cant push too much on, as any large deviations will conflict with what they have no control over, such as ADP payroll reports.  The strategy then could backfire on them. Nevertheless, there's not much left in the ammo box, and they will certainly use what they have. They know that whatever great news they publish will end up being headlined on CNBC, Fox Business, MSNBC... everywhere.  The permabulls will be screaming in celebration as they try to discredit those of us who have been trying to warn them.

Speaking of PIGS and Europe in general, I wouldnt believe everything that comes out of them either.

BlingBlingBen's picture

"I'm going to make you rich. You just have to be my bitch."

dcb's picture

i read the ft, dividend yeild on the dow equals yeild on treasury. this is their buy metric.

on the tlt, draw the chart as if lehman didn't fail.

phaesed's picture

Ummm.... maybe just the first round of pomo's have been completed so time to sell the remaining excess stock to the late comer treasury buyers?

phaesed's picture

oh yeah and all the usual overbought indicators, huge gaps, etc, etc.... sheesh, always the need to rationalize the obvious?

Number 156's picture

With Goldman, the book always speaks first.

web bot's picture

They have spoken... so stand up.

Take something blunt but not too sharp and start to bang your head with it (anywhere on your head is fine). As you do this, mutter the word "trillions", over and over again.

After you come to, pick yourself up off the floor and continue repeating the word "trillions" until the pain in your head finally leaves. When it does, repeat the process and start to hit your head again with the object...

Continue doing this until your hear a sensible plan coming out of Washington as to when when the deficits are going to end. You'll probably be dead by the time this happens.

I hope you are getting my message.

web bot

HarryWanger's picture

Glad I bought TBT yesterday afternoon. Had to figure this would happen sooner or later. Like I said yesterday, yields could continue lower but can go much higher a lot faster.

anony's picture

I'll tell you why. For the first time ever, after watching my TBT decline by 15.00 over the last several months,  I finally threw in the towel and bought a contract on the 30 yr T.

That's why.


besodemuerte's picture

This just in from CNBC's superstar analyst Bob Pisani...

"GDP revision breaks string of disappointing data"




So beating an estimated -1% downward revision by only revising by -0.8% is actually good news?

old_turk's picture

Well, according to Bob that 0.2 not downwardly revised is good for a 10 handle of the Dow.

Actually, I think sector rotation to defensive (read dividend paying) stocks continues with renewed urgency.

Check and see if the Hindenburg Omen clicks again today.

Grand Supercycle's picture

As first suggested on Thurs 26th, further upside for DOW/SP500 is expected.

Alchemist's picture

Teh quality of intelligence in ZH comments are deteriorating pretty fast.. Here is one catalyst: SMR survey printed 101.5 showing market extended on the long side, hoping for QE.. and on top of that JGBs puked 7bps last night on thni air.. Just like summer 2003.. Another 25bps next week at least..

Fruffing's picture

Tinfoil aside, what's the read on the long end?   I didn't think pension demand was that significant, rather inflation expectations.  

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