Just two short weeks ago, the yield on the 10 Year Bund was in the single basis points and flirting with zero, if not negative. Since then, first Gross, then Gundlach realized the very simple math of shorting negative yielding fixed income instruments which we laid out simply here a week ago...
Gross is smart: when you short negative yielding bonds you have a positive carry
— zerohedge (@zerohedge) April 23, 2015 [13]
... and since then the Bund has tumbled, with yesterday seeing the sharpest drop and according to Commerzbank, flash crashing [14], following news that after three years of negative loan growth Europe may be finally renormalizing, a first step to if not the outright end of ECB QE, then certainly a taper.
But while many thought the selloff had peaked yesterday, and would henceforth be more orderly, they were proven wrong, when right out of the gates this morning, investors were very, so to say, bunderweight, on the German benchmark govvie and the yield promptly gapped up as high as 0.38% before retracing some of the sharp move higher.
A move which as the following chart shows may be just the beginning if the weekly support is taken out:
Before you get too bearish of #Bunds [17].... Weekly chart.... pic.twitter.com/sHswO1BcQU [18]
— Clive Lambert (@FuturesTechs) April 29, 2015 [19]
As we noted yesterday, the sharp move higher in yields started yesterday. What caused it, UBS asks, and answers: "Not fundamentals."
Euro bond yields started to rise well before the 13:30 releases of Germany CPI and US GDP. German CPI was fairly close to consensus estimates in any case. Moreover, European bond yields spiked in advance of the equity sell-off and strengthening EURUSD. In our view, the moves today were driven largely by technical factors. [20]
Positioning
Many European investors, especially asset managers and hedge funds, are tactically overweight duration. These overweights have persisted for some time, ahead of the well anticipated sovereign QE programme. We and other observers have argued many times that markets are prone to episodic volatility, as dealers have limited capacity to warehouse risk. The move today fits this thesis.
Several consensus positions in European rates are centred around the expectation that sovereign QE will result in a scarcity of bonds leading to a price squeeze. Three positions stand out:
• overweight duration in core and peripheral markets,
• long 10yr Germany vs swaps (also captures Greek risks) and
• yield curve flatteners.
The magnitude of today's moves suggests that exposures could be quite large.
The sell-off in Europe almost certainly was exacerbated because it occurred on the day of the FOMC meeting. US market-makers naturally are disinclined to add risk only hours before a Fed announcement, even one that is expected to be tame. Investors also usually refrain from shifting risk exposures on Fed today. Even so, UBS traders reported that investors were net buyers early in the US trading session.
Speaking of positioning, perhaps the biggest drive of the Bund weakness as we enter May is that German net flows turn from sharply negative to modestly positive, suggesting the technical pressure will be far less.
However, in June and later the flows flip again, and German net flows once again become strongly negative.
So what's a bond trader to do?
Perhaps Socgen summarized it best when it said that "this is not what the ECB's QE was supposed to do: euro up, bond yields up, stocks down." Oops.
It adds that "it worked to a tee between January and mid-April but oil prices and the US economy are starting to spoil the party." and that "without a strong US partner, QE in the eurozone will mean very little without structural reform. The message to EU officials: this time a stronger euro really isn't the ECB's fault."
For now the EURUSD is moving in lockstep with the Bund yield, and moments ago it rose to 1.250, a two-month high, which in turn pushed both European stocks and US equity futures to session lows.
Still, the most notable thing over the past 48 hours is the sheer velocity and pace of the selloff, proving once again just how illiquid the market is, and that when one of the most concentrated positions begins unwinding, the market may very well simply go bidless. Or just shut down entirely.





