Bond Bear Short Squeeze Accelerates As Traders Dump Inflation Bets

US Treasury yields have tumbled in the last three weeks (with the belly of the curve outperforming) as a plunge in inflation expectations and a safe-haven bid protection from equity carnage combined to squeeze the record net short positioning.

Since Columbus Day, yields have plunged with the tails (2y and 30y) underperforming (thought still lower in yield) as the bely (5s and 7s) compresses notably...

While safe-haven flows are likely helping bond yields compress, it is inflation expectations that are collapsing.

Bucking the trend of the business media narrative that prices are soaring and costs are spiking due to tariffs, we already noted that UMich inflation outlook is at record lows...

And, as Bloomberg reports, the five-year breakeven rate, which represents bond investors’ view on the annual inflation rate through 2023, dropped Friday to 1.88 percent, the lowest since January.

While breakevens peaked in May, the decline has gained momentum, leaving the five-year rate about 30 basis points below its 2018 high. Some of that drop may be oil-driven. But crude is still up about 10 percent for the year, suggesting the cause may go deeper.
As Bloomberg notes, the answer seems to be that breakevens have declined since short-term swap rates adjusted for inflation began signaling that Fed policy had become restrictive.

Specifically, the most recent tumble in breakevens happened after the inflation-adjusted one-year one-year swap rate rose above 100 basis points, meaning it was restrictive by 30 basis points.

The Fed may have entered restrictive territory by a full quarter-point hike, by that analysis, and the markets could be sending that signal.

Which is why stocks and breakevens have recoupled to the downside...

Additionally, inflation and growth expectations reflected in commodity prices suggest that 10Y Treasury yields should be dramatically lower from here...

Imagine what a 65bp compression in the 10Y yield would do to that record short duration bet?