RBC: “That Is VaR Crushing DV01 Destruction At Its Finest”

If traders aren’t looking at global rising bond yields, and increasingly steeper curves, they should be because as RBC’s head of criss-asset desk strategy Charlie McElligott says in his latest market note, “That is VaR crushing DV01 destruction at its finest.“

Here are the highlights:

GLOBAL RATES AGAIN DANGEROUSLY HIGHER, BUT STOCKS AND VIX RELAXED

The absolute focus overnight / today is “core” macro though, as global developed market rates are being re-priced “risk manager style,” particularly with EGBs under MAJOR pressure as the buyside is caught wrong-footed (as I type, Slovak 10Y +7.2bps, Denmark 30Y +9.4bps, Netherlands 30Y +9.9bps, Finland 30Y +10.1bps, German 30Y +9.9bps, Austria 30Y +9.3bps…and even front-end seeing outsized moves with the Belgian 2Y +2.2bps). That is VaR crushing DV01 destruction at its finest.

Without question, a constant theme we’ve hit on in the “Big Picture” over the past few months is the risk of a market hyper long duration on lazy QE-induced “yield compression” trading, into an environment where CBers in coordinated fashion are telling us they want to steepen the curve / get long-end yields “higher” (overnight Kuroda stated exactly “this” desire to see long yields rise / steeper curves—and even “alluding to” future tapering by saying that the BoJ may not need to buy Y80T of bonds indefinitely—H/T Todd Cross). Why are so many caught “wrong” by this? Perhaps it’s a “fool me once / fool me twice” dynamic of market complacency with CB rhetoric. But I have also referenced (since early Summer) the danger of the “false signal” of “mechanically” lower rates, as many have misinterpreted them as a direct read on “low growth” / “low inflation” in perpetuity…when in fact, much of it was simply due to said “duration grabbing yield compression” from the “real money” universe (and piled-on by momentum-chomping systematic CTA / trend-following community) in light of CB NIRP policies and unprecedented asset purchases.

Now we too are seeing nascent signs of an inflation expectation “readjustment” as well (BE’s / inflation swaps and zeros / ‘cyclical : defensive equities ratio’ all at or near year highs, and our govies desk has seen nothing but buyers of TIPS all week) in large part via the crude “base effect” (and if in the US, also seeing inflation in healthcare and rents, while wages tickle higher on top of that)…while global manufacturing PMIs look strong (overnight two more positive manufacturing data points with Swedish and Italian Manu Confidence beats) and we get another GDP beat (UK Q3 GDP 2.3% vs 2.1% est) as well—i.e. the data is nowhere close to ‘as bad’ as the majority thought it was going to be.

And “oh yeah,” a Dec hike is now being priced at a ~75% probability. Where I come from, we call that a “perfect storm” for a world choking on “risk free yield.” And part of the issue we have now which is worth reiterating is that the “overseas ALM community” has moved that 1.80 “buy zone” level higher, where it sounds like the next level is likely close to 1.86%.

I have spoken about the amount of length in the global steepener trade–which inherently makes me nervous as it looks to be a “no brainer” consensus trade–but that continues to look like the “right” place to be, as the long-end is back under significant pressure in major sovereign bond markets. Again, this is bc central bankers from the BoJ (Kuroda himself now, but “kicked off” by the mad-scientist Sakurai first who commenced the September “taper tantrum”) to the ECB (“sources” report two weeks back) to the Fed (Rosengren two Friday’s ago) getting in on the CLEARLY COORDINATED MESSAGING.

Further to the “steepening” point…this is what I said last week after Rosengren’s statement that “…we have the flexibility to steepen the yield curve and there are a number of ways we could potentially do that.”

“But back to the “steepening” convo at hand: this is further proof that this “CB group re-think” IS occurring—an acknowledgement that you can’t keep buying bonds at this pace forever without creating utter dysfunction…unless of course the mandate is moved to debt monetization / helicopter money. As a reminder, the BoJ actually put their ¥ where their mouths were, actually purchasing fewer 10Ys in their last end-September operation than previous ones, as yields were seemingly too far out of scope / too negative at the time—IT IS HAPPENING, SLOWLY BUT SURELY. This CB re-think then means that the market regime needs to also shift, because a flattening curve in the recent past was essentially a statement from the market in a belief that QE was working. Now, this (admittedly longer-term) CB shift means an eventual “tapering” from those active QE participants (BoJ, ECB, BoE) is prerequisite…even if they try to execute the steepening in a sterilized fashion.”

Mind you, we also have this VERY CONTRA- inflation story to juxtapose this against, with regards to the recent and massive USD strength as a major headwind (and clearly the psych / real effect of the Yuan fix “devaluation,” although the SDR basket holds sideways—meaning this is more about the Dollar). All in all, it’s quite reminiscent of last year with the Dollar / RMB / Fed interplay as we pushed into year-end, where it seems the Fed has put their blinders on with regards to the dangerous “policy divergence” narrative, and the implications for inflation, commods and EM. The market is going to have to “true-up” on these conflicting messages soon.

EU 2s30s CURVE ON THE “GIDDYUP:”