Since their peak 'shortedness' in mid-January, US Treasury bond bears have covered 500,000 10-year-equivalent contracts, reducing the net speculative short to its lowest since before Thanksgiving 2016.
At the same time, however, Eurodollar shorts (bets on Fed rate hikes) have soared to a new record high (over $3.2 trillion notional).
However, both the absolute level of Treasury yields and the short-term eurodollar curve (bets on The Fed's path in the next 18 months) are losing their faith in Trumpflation and Janet Yellen.
Bloomberg's Tanvir Sandhu notes that the intermediate and long-term Treasury yields have broken down from this year’s ranges and are now at their post-election lows, given the confluence of global political-risk events and increased doubts about the prospects for sizable tax reform. Investors need to quantify how much of President Donald Trump’s policy agenda is left in the price and the risks if policy disappoints.
Deutsche Bank now sees the balance of risks as tilted toward still lower yields across the curve in the near term. Last week we revised our forecasts to reflect a near term dip in 10y yields toward 2%, with yields ending the current quarter at 2.25% and climbing to 2.75% by the end of 2017.
This path reflects concern for risk off conditions driven by the French electoral process, significant delays or even failure of pro-growth tax reform in the US, a possible slowdown in “soft” indicators such as our excess liquidity metric, and positioning.
However, there remains a plausible path to higher rates. If the French electoral process is not acutely disruptive, if progress is eventually made on tax reform, and if the data remain resilient then rates should rise again and the Fed could push on. In this sort of scenario the Fed’s trade-off between balance sheet reduction and rate hikes would likely come into greater focus.
However, for now, futures positioning and options skews show bond bears losing the fight.
As Bloomberg reports, the cost of options to bet that U.S. yields will fall in the near term has now moved higher than those to position for an increase. With volatility beyond three-month expiries still relatively low, this boosts the appeal of hedging against mounting geopolitical risks via spread options. Short-dated skews on 10-year rates have turned negative, with receivers trading at a premium to payers. The flattening of short-dated skews increases the attractiveness to hedge against lower rates via receiver spreads. These skews tend to predict subsequent changes in underlying rates, with flatter skews since December having indicated risks to duration shorts.
“North Korea and Syria were the straw that broke the camel’s back, but now we have a new range,” said Glen Capelo, a trader at Mischler Financial. He pegs it at about 2.05 percent to 2.4 percent for the 10-year yield, after it’d been stuck between 2.3 percent and 2.65 percent.
For bond bears, “we’re not going to know anything for a while,” on the timing of Trump’s fiscal-policy agenda, Capelo said. “The onus now is that the hard data has to turn higher.”