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Bond Crash Continues - Aussie & Japan Yields Burst Higher

Tyler Durden's picture




 

The carnage in Europe and US bonds is echoing on around the world as Aussie 10Y yields jump 15bps at the open (to 3.04% - the highest in 6 months) and the biggest 2-day spike in 2 years.  JGBs are also jumping, breaking to new 6-month highs above 50bps once again raising the spectre of VAR-Shock-driven vicious cycles...

 

 

The spectre of a self-feeding dynamic is something we’ve discussed at length before, most notably in 2013 when volatility-induced selling — reminiscent of the 2003 JGB experience — hit the Japanese bond market again, prompting us to ask the following rhetorical question: 

What happens to JGB holdings as the benchmark Japanese government bond continues trading with the volatility of a 1999 pennystock, and as more and more VaR stops are hit, forcing even more holders to dump the paper out of purely technical considerations? 

The answer was this: A 100bp interest rate shock in the JGB yield curve, would cause a loss of ¥10tr for Japan's banks.

What we described is known as a VaR shock and simply refers to what happens when a spike in volatility forces hedge funds, dealers, banks, and anyone who marks to market to quickly unwind positions as their value-at-risk exceeds pre-specified limits.

Predictably, VaR shocks offer yet another example of QE’s unintended consequences. As central bank asset purchases depress volatility, VaR sensitive investors can take larger positions — that is, when it’s volatility times position size you’re concerned about, falling volatility means you can increase the size of your position. Of course the same central bank asset purchases that suppress volatility sow the seeds for sudden spikes by sucking liquidity from the market. This means that once someone sells, things can get very ugly, very quickly. 

Here’s more from JPM on the similarities between the Bund sell-off and the JGB rout that unfolded two years ago:

The sharp rise in bond volatility over the past week or so is reminiscent of the VaR shocks of October 2014 in US rates and April 2013 in Japanese rates. The common feature of these rate volatility episodes was that there was no clear fundamental trigger. Instead, positions and flows experienced a sharp swing making these VaR episodes appearing more technical and unpredictable in nature. In October 2014, a violent capitulation on short positions at the front-end of the US curve had caused a collapse in UST yields. In April 2013, profittaking in long duration exposures post BoJ's QE announcement caused a sharp rise in JGB yields that started reversing two months after. 

What is causing VaR shocks and why are they happening often? We argued before that one of the unintended consequences of QE is a higher frequency of volatility episodes or VaR shocks: investors who target a stable Value-at-Risk, which is the size of their positions times volatility, tend to take larger positions as volatility collapses. The same investors are forced to cut their positions when hit by a shock, triggering self- reinforcing volatility-induced selling. This, we note, is how QE increases the likelihood of VaR shocks.  

 

The proliferation of VaR sensitive investors, such as hedge funds, mutual fund managers, risk parity funds, dealers and banks raise the sensitivity of bond markets to self- reinforcing volatility-induced selling. These investors set limits against potential losses in their trading operations by calculating Value-at-Risk metrics. Value-at-Risk (VaR) is a statistical measure that investors use to quantify the expected loss, over a specified horizon and at a certain confidence level, in normal markets. Historical return distributions and historical market volatility measures are often used in VaR calculations given the difficulty in forecasting volatility. This in turn induces investors to raise the size of their trading positions in a low volatility environment, making them vulnerable to a subsequent volatility shock. When the volatility shock arrives, VaR sensitive investors cut their duration positions as the Value-at-Risk exceeded their limits and stop losses are triggered. This volatility induced position cutting becomes self- reinforcing until yields reach a level that induces the participation of VaR-insensitive investors, such as pension funds, insurance companies or households.  

 

The VaR shock in the JGB market in April 2013 contained most of the above characteristics. By looking at quarterly Flow of Funds data from the BoJ, it was Japanese banks, Broker/Dealers and foreign investors who sold JGBs at the time. And it was VaR insensitive investors, such as Pension Funds and Insurance Companies and Households (via investment trusts) who absorbed that selling along with the BoJ.

As we warned last time, it appears the fireworks are far from over.

Charts: Bloomberg

 

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Wed, 06/03/2015 - 20:59 | 6161427 Soul Glow
Soul Glow's picture

Draghi needs to BTFD!

Wed, 06/03/2015 - 21:11 | 6161449 Captain Debtcrash
Captain Debtcrash's picture

Not sure if this is the beginning of the end for the greatest bubble to this point, the world wide sovereign debt bubble, but even if not, we know this debt taken on by fools was never going to be paid back. Default or a default thought inflation, or a default into a new monetary system. No matter how they phrase it, the creditors will lose.

Thu, 06/04/2015 - 02:04 | 6162055 LukeCV
LukeCV's picture

He already bought the FATH!

Wed, 06/03/2015 - 20:59 | 6161429 stant
stant's picture

Will the next false Flagg work to scare them back into bonds?

Wed, 06/03/2015 - 21:17 | 6161469 Evil Bugeyes
Evil Bugeyes's picture

How can JGB yields be spiking when the Japanese central bank is the only buyer? Have they finally run out of privately-held JBGs to buy?

Wed, 06/03/2015 - 21:19 | 6161477 Salah
Salah's picture

2 things: Fed jacks up i-rates on all that US Dollar denominated global debt

and Obama's gone totally limp-dick with China on the S.China Sea fiasco & TPP


Wed, 06/03/2015 - 21:26 | 6161497 max2205
max2205's picture

Did someone hide The print button?

Wed, 06/03/2015 - 21:27 | 6161499 Seasmoke
Seasmoke's picture

Are people actually still paying off unsecured debt ????

Wed, 06/03/2015 - 21:42 | 6161535 Goldilocks
Goldilocks's picture

Bloodhound gang- The roof is on fire (HQ sound)
http://www.youtube.com/watch?v=ChmUC0OysoU (4:56)

Wed, 06/03/2015 - 21:55 | 6161570 tok1
tok1's picture

whats happened to zhedge this is all over exaggerated Japan yields have harldy moved (2-3bp higher) and Aussie too.. their actually stabalizing US tres (firming a bit)

 

The sites become anti US exaggeration.. it use to report facts.. 2-3bp move is no crash

Wed, 06/03/2015 - 22:00 | 6161581 Goldilocks
Goldilocks's picture

Everything Is AWESOME!!! -- The LEGO® Movie -- Tegan and Sara feat. The Lonely Island
http://www.youtube.com/watch?v=StTqXEQ2l-Y (2:44)

Wed, 06/03/2015 - 22:08 | 6161612 Yen Cross
Yen Cross's picture

  And the Nikkei is up... Good grief.  The Asian equity markets are due for a nasty retrace.

Wed, 06/03/2015 - 22:10 | 6161622 fremannx
fremannx's picture

The yield on the 30YR UST is about to push over the 3% mark and the 10 YR is right on its heels...

 http://www.globaldeflationnews.com/10-year-u-s-treasury-index-yieldellio...

Wed, 06/03/2015 - 22:50 | 6161734 q99x2
q99x2's picture

This looks like fun. I want to play.

Thu, 06/04/2015 - 00:01 | 6161905 Market Rage
Market Rage's picture

Interesting thing to note.  The NDX is at about the same level as it was on 4/27, but ~ 75 of the 107 components are lower now.  including AAPL GOOG  MSFT AMZN...........Crazy.

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