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The Bond Market Explained Part II

EconMatters's picture




 

By EconMatters

 

 

Addendum Needed

 

Since so many people are still slightly confused about how all the pieces come together in this move lower in yields, we feel the need to add some follow-up commentary to our previous article entitled "The Bond Market Explained for CNBC" on the subject which should help investors better understand the behind the scenes dynamics of the bond market.  

 

Filling in the Details

 

So the High Yield Carry Trade is what has brought the 10-Year down to the 2.62% area, Hedge Funds started realizing what was going on in the Bond market, and started getting involved when yields were around 2.8%, but they are just jumping on the tails of the High Yield crowd with the size required to move this market 50 basis points.

 

Once we settled into the 2.62% area hedge funds made a run for the 2.58% area lows, then covered and we were back up around 2.65% yield. From there European Bonds started rallying in price, going down in yield on the belief that Mario Draghi was going to do some kind of stimulus program involving bond buying, investors wanted to front run this event, this led US Bonds to also rally in price and go down in yield which is the move down to 2.47%, then the traders covered and we retraced back to the 2.56% area yield. 

From there traders waited until the econ news came out on Tuesday where yields rallied, and then with no econ data to worry about made the next push down to the 2.43% area on Wednesday in a relatively light volume trading environment. This is straight out of the trend trading handbook, and traders have yet to cover this latest push down hoping for additional profit with protective stops in place. 

 

Make no mistake this is just a trade for these folks with no long-term conviction regarding where bond yields should trade relative to the economic fundamentals. These same traders will be pushing in the other direction in a couple of months; this is how momentum trading works these days.

 

Market Moving Events Next Week

 

There is economic data on Thursday with GDP revisions and Jobless Claims numbers, but relatively speaking, next week is where the rubber meets the road on this trade. Hedge Funds are piling into this trade trying to push some technical areas in a light volume week, see where yields end up next Friday for any commitment to this trade by Hedge Funds. 

 

 

My guess is that there is major covering or closing out of positions by the end of next week similarly to how the Hedge Funds all ran out of the Natural Gas trade, sending NG Futures down two bucks in two days as nobody wanted to take delivery of said natural gas in their largely paper world. 

 

Lots of Stops Protecting Profits

 

Therefore, to sum up the High Yield chasing environment fueled via Low Interest Rates for Borrowing are the reason all rates are this low, but this last move down in bond yields has been due to front-running the ECB decision on June 5th, and hedge funds piling in as they always doing smelling blood in a hot market for technical damage. 

 

As an aside, these aren`t high yields all things considered, but high relative to essentially zero percent borrowing costs once you factor in the kind of leverage being used in this trading strategy.

 

It might be worth pointing out that the bond market is tightening like a coiled spring and can explode higher in yields an easy 20 basis points at the drop of a hat, look for the ECB Meeting or the USEmployment Report to be a potential catalyst next week!

 

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Thu, 05/29/2014 - 15:03 | 4806846 MassDecep
MassDecep's picture

I heard a comment from  Danielle Park http://kerrylutz.libsyn.com/danielle-park-27may14

regarding the bond market rush to US safety. Something like we are the safest of all the fiat at the moment.

 

Thu, 05/29/2014 - 20:19 | 4808024 Redneck Hippy
Redneck Hippy's picture

Yep, except French bonds are trading at lower yields than in the U.S.  That's bankrupt France with the exploding unemployment rate.  All sovereigns everywhere seem to be dropping in yield, counter to all logic and intuition.

Thu, 05/29/2014 - 15:25 | 4806963 ebworthen
ebworthen's picture

Yup.

Compliant populace, huge M.I.C., and a Central Bank willing to throw however many trillions it takes at the Big Banks to keep the ponzi rolling.

Thu, 05/29/2014 - 14:19 | 4806577 Fuh Querada
Fuh Querada's picture

So where is your analysis of the OTC interest rate derivative contracts?

  “What we’ve seen over the last six months is a ramp-up in interest rate swaps to the tune of $12 trillion . . . . What the build in these interest rate swaps is achieving, it’s stemming the rise in interest rates.”

http://usawatchdog.com/colossal-fraud-there-are-no-free-markets-rob-kirb...

Thu, 05/29/2014 - 14:07 | 4806501 ebworthen
ebworthen's picture

"Paper world" about says it all, eh?

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