While the algos are closely following every momentum-generating uptick in global equities on the back of yet another short squeeze in crude, one asset class that has been roundly ignored are Treasurys, which have refused to follow the equity euphoria and have in fact roundtripped today’s entire risk on move, suggesting that once again, “bonds aren’t buying it.”
And, if Bank of America analysts Shyam Rajan and Dora Xia are correct, don’t expect any “taper tantrumy” bounce in yields any times soon. According to the bank’s analysts there are three reasons against a quick turnaround.
The expected short covering bounce in risk assets and the modest back-up in rates beget questions on whether too much pessimism is already priced in and if we are setting up for a tantrum trade similar to summer 2013 and spring 2015. We do not think so. There are three reasons why this time is different and rates will find it hard to move higher sustainably, absent a coordinated policy response.
1. The move lower in yields is different
Prior tantrums in rates occurred only when the rates market decoupled from risk sentiment and investors were lured into an overweight duration position on the back of QE. This is best illustrated in Chart 1.
- 2013 US tantrum: Following the announcement of open-ended QE by the Fed, rates decoupled from equities in early 2013 as investors were lulled into duration longs despite strong equity markets on the back of “QE infinity.”
- 2015 Bund tantrum: The ECB’s announcement of QE in early 2015 led to a sharp disconnect between Bunds and European equity markets, as investors believed that the lack of supply would drive bund yields negative.
Unlike the prior episodes, the current move in rates reflects genuine risk-off flows and not just extended positioning. This is evident in the $45bn of outflows from equity funds and $32bn inflows to bond funds. In contrast, leading to the 2013 tantrum, equity funds and bond funds both had inflows: $38bn for equity and $17bn for bonds.
2. Do not take comfort in the “bad” dollar sell-off
Even though the strengthening dollar was one of the greatest headwinds to growth last year, we take no comfort in the recent weakening of the currency. As our BofAML sentiment survey shows, investors have moved from considering China as the biggest risk in 2016 to fearing slower US growth. This shift has helped push any expectations of tightening well into the future, lowered the terminal rate, and further lowered inflation expectations. The weaker dollar is a byproduct of easier Fed policy being priced in, and not necessarily a welcome sign. The correlation between the dollar and rates and dollar and breakevens has turned positive – weaker dollar, lower rates and weaker dollar, lower breakevens – proof that this is a “bad” dollar sell-off (Table 1).
3. If recession risks fade, the old fault lines in China reappear
As our FX strategists have clearly pointed out, the recent move in the dollar has not only removed the spotlight from China but also has helped the situation there in two ways. Lower US rates helped reduce the pressure on outflows, given that capital flows are historically correlated with interest rate differentials (Chart 3). A weaker dollar has reduced pressure on the PBOC to deliver higher USD/CNY fixings. However, if US recession risks fade, the resulting strengthening in the dollar and higher rates will reignite the same risks in China for the market as in August 2015 and January 2016.
The above three factors lead us to believe that a repeat of last year’s sell-off in rates is unlikely given the current backdrop. Essentially, the rates market is stuck between pricing in more Fed easing or more China worries.
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Which explains why anyone hoping for a big drop in Treasurys will likely be disappointed. So if one can’t trade the short Treasury trade, maybe going long is the right trade. That is what Guggenheim’s CIO Scott Minerd is betting.
Cited by Reuters, Minerd, said on Monday that he sees the 10-year Treasury note yield falling to 1 percent, perhaps even lower, before year-end.
Much lower: “According to technical analysis, the current target bottom for the 10-year Treasury note is 28 basis points,” Minerd told Reuters. “That may seem like voodoo, but technical analysis provided key insight to our macroeconomic team a year ago when we called for oil to hit $25 per barrel back when it was trading at $60.”
If he is right, that would mean that the risk of a US recession using the Fed’s adjusted yield curve calculation first revealed by DB and subsequently adopted by everyone else, is at 100% or just a little big higher.
via Zero Hedge http://ift.tt/1Q5XzmX Tyler Durden