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 [8]- 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.
[9]
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!
[10]
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.
[11]
Source: New York Fed [12], H.8 [13] [13]