There has been much debate over the causes and driver behind the recent meltdown in bond yields (see "Here's What Wall Street Thinks Is Behind The Shocking Plunge In Yields"), with a survey by Deutsche Bank finding that roughly half of Wall Street strategists are arguing for fundamental reasons such as resurgent covid fears due to the Delta variant, the Fed's hawkish pivot and a chronically depressed r* indicating secular stagnation (a very concerning argument made by DB's George Saravellos)...
... while the other half betting that technicals are behind the move, with Barclays strategist Anshul Pradhan writing that while driven by growth concerns possibly arising from virus trends and the Fed’s hawkish turn, the rally was “exacerbated by short covering of bearish positions” by both CTAs/macro hedge funds and fixed-income mutual funds. Indeed, the recent JPM fund manager survey showed that most rates traders are bearish on rates, which would explain the recent short squeeze.
Since this debate is likely to continue, below we present a handy summary of the most widely cited reasons for the rate move courtesy of Rabobank's Michael Every:
- The Delta, Lambda, and now Epsilon variants of Covid-19, and a Tokyo Olympics without spectators (or sponsors)? Big Pharma is already gearing up for permission for booster shots, and the White House is suggesting these may even go door to door, so markets can seize on that literal shot in the arm if they want to - unless one of the ‘greeks’ really is vaccine resistant;
- That everyone had been shouting “Reflation Now!”, and so was short Treasuries? That positioning issue seems logical – and has anyone actually gone long bonds yet?;
- That US Treasury cash balances have been drawn down while the Fed has been doing the same $120bn of QE a month, sucking up net supply? That seems logical too, even if it can’t last forever; and
- The Fed’s tapering pivot/policy error? Which would be interestingly cynical from the markets if so; And/or
- That without fiscal stimulus AND supply chain/structural reform, the “criminally vulgar” US economy is one looped Smiths album re: wage reflation, which is always “nothing in particular” for too many sons and heirs?
Whatever the reasons behind the recent move, what markets care about now is what happens next, especially after the 10Y tumbled yesterday to the lowest level since February before bouncing perfectly off the 200DMA.
As for what happens next, there are two key drivers: one fundamental and one technical. First looking at the former, Bloomberg picks up on the net issuance theme discussed yesterday (recall that in an extremely rare even, "on a rolling 3-month basis the entire net supply of treasuries had recently been taken down by the Fed on a net basis")
... and notes that the bond market is, belatedly, bracing itself for $120 billion of new coupon paper on Monday and Tuesday and that "investors will likely lean into the Fed’s long-end buyback operation to set up for some of this supply."
Indeed, as shown in the chart above, yields are higher for the first day this week as the focus shifts to next week’s auctions, supply which includes $58 billion of new three-years and $38 billion in reopened 10-year notes on Monday. Some $24 billion in reopened 30-year bonds will be sold on Tuesday.
But those who are betting on a continued rise in yields, may be disappointed for one key technical reason. As Morgan Stanley's derivatives strategist Chris Metli notes, CTAs - those mindless trend-followers who just ride on momentum waves until they crash - are still short bonds and at current yields have to buy $95bn notional of TY-equivalent duration over the next week, which as Morgan Stanley says "could continue the bond rally and put pressure on stocks as equity investors fear the bond market knows something they don’t about future growth prospects."