JPM: CTAs Were Reponsible For The Recent Treasury Selloff; What It Means For Treasury Yields

On Saturday morning we showed that  as the yield on the 10Y US Treasury note broke above the 3.00% Maginot Line this week (for the first time since Jan 2014), spec traders (hedge fund) piled on - pushing net speculative positioning for 10Y note futures to their largest short ever. In fact, along with almost $4 trillion notional in Eurodollar shorts (betting on rising short-term interest rates), the aggregate position across the rest of the Treasury futures space has also reached a new record short, which, as the chart below shows, is equivalent to well over 1.1 million 10Y futures contracts.

However, as we have repeatedly said in the past, spec positioning, as indicated weekly by the CFTC reports, is a lagging, not leading indicator, and thus has little informational value. Furthermore, while incremental, the additions to the net short position were hardly "marginal", which likely means that the accelerated unwind in the Treasury complex in the second half of April, had little to do with another short pile up, and more to do with the closing out of long positions.

But who was selling? According to one apocryphal theory, the marginal seller was none other than Beijing, perhaps in retaliation, and as a warning signal, for the recent escalations in the ongoing trade war between the US and China. It will be impossible to confirm or deny this theory until full TIC data for April is released in two months (and even the data is price/yield adjusted) although the recent plunge in Treasuries held in custody at the Fed - the biggest since the China deval days of January 2016 - suggests that China may indeed be liquidating at least a modest portion of its TSY holdings.

Another, more actionable theory was proposed on Friday by JPM's Nikolaos Panigirtzoglou, who writes in his weekly Flows and Liquidity report that CTAs have been partly responsible for the bond market sell-off since mid-April.

The reason, as JPM notes, is that unlike the rest of the investing world which has been solidly short the Treasury complex and merely adding more incremental shorts, CTA have undergoing a sharp reversal in position, a marginal move which had the biggest impact on price. Panigirtzoglou explains:

We had argued previously that momentum-based investors such as CTAs had likely turned long duration around the end of March. Indeed, the shorter-term momentum signal turned long on March 22. When we apply both shorter- and longer-term momentum in combination our revised framework suggests that they likely cut risk and turned neutral rather than shift to outright longs as longer-term momentum continued to signal duration shorts.

This is shown in the next two chats, the first of which (Figure 6) showing the time series of the z-scores of both the shorter-term and longer-term momentum, while Figure 7 shows the position implied by JPM's two momentum signals, one based on short-term momentum only as well as a new, recently revised combined momentum signal.

JPM's conclusion:

[CTAs] had a bias to be short since mid-September, and consistently been short from mid-December to end-March. After being neutral for nearly a month, the combined signal then turned short on April 18, suggesting that CTAs have been partly responsible for the bond market sell-off since mid-April."

And what it means for prices going forward:

Given that a shift to shorts by CTAs is likely to have taken place over the past week and a half in our framework, we think that momentum traders are less likely to remain as a strong bearish force for 10y USTs going forward

If JPM is correct, and it is not China but rather momentum chasers that were responsible for the sharp selloff in the past two weeks, then expect an even sharper drop in yields in the coming days as the recent attempt to break out above 3.00% was firmly rejected and as momentum signals behind the highly volatile, temperamental and marginal price creating trend-following community reverse in the next few days.