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Duration is No Longer “Trending”

So, you know how every once in a while you hear from someone who’s been trading for a few decades & they say something like “this market feels completely & totally broken…”?

Try this one on.

The CTA community has likely sold back $100bn+ 10-yr Treasury equivalents in the last 5 days…and that number is only going to grow.

For those “duration-starved asset managers” who were wolfing down bunds at -80bps, the trend [follower] is proving to be very unfriendly, indeed.

Year of the macro trend…

Clearly 2019 has been the year of the Macro Trend & it’s indisputable that the break lower in global bond yields signaled one of the larger trend shifts in some time.

Those who caught the move benefited enormously. Various barometers of CTA performance are up anywhere from 10-20% YTD. The performance of the two (buying Treasuries & CTA % returns) have been closely linked.

But, it also became difficult to square the incessant buying that was rampant in safe haven space with the fundamentals of buying a negative yielding asset. For those positive yielding assets, it was a remarkable move – but also one that had skeptics pointing towards the fact that the Fed’s own measure of 10y Term Premium was well below -100bps, lower (by a lot) than it had ever been since the early 1960s when the Fed began tracking.

In Europe, the same debate raged. It wasn’t tough to argue for buying bunds as they broke 0.00% in the spring, but as levels approached -0.80% the question became a lot more pressing. You’d need to make some extreme assumptions for how much further the ECB would need to cut in order to just break even.

So who was buying all those bonds, anyway?

The answer as to the buyers was variously given as A) duration-starved asset managers who were desperately trying to lock in the last bit of yield globally before the bottom fell out of the “reversal rate”, or B) trend-followers.

I will note that, rather than placing all the blame on CTAs, it’s important to note that as recently as 2wks ago, the CEO of CalPERs stated they had a 6.1-7.0% total return assumption for the next 10 years. That assumption only works if you think stocks are planning to double or Treasuries are going thru zero in the next 2 years. And you’d need to buy a lot of Treasuries in that scenario.

JP Morgan went a little further in their note this weekend to put some detail around the speculated cohort of negative-yield-demanding investors:

Buyers include: 1) investors that fear or expect deflation; 2) investors that speculate on currency appreciation; 3) investors that expect capital gains resulting from central bank easing; 4) central banks themselves, particularly when conducting asset purchase programs; 5) indexed or passive multi-asset and bond funds; 6) banks who seek to avoid potentially even more negative deposit rates; 7) foreign investors who may find negatively yielding bonds attractive after FX hedging is accounted for; 8) CTAs and other momentum-based investors who are price-based rather than yield-based investors; and 9) some insurance companies and potentially pension funds that may be forced by regulations to de-risk or reduce duration mismatches even as yields turn negative.

It would appear we have our answer. Because they are now selling.

A lot.

In late August, one of the classic standbys of the trend following community – MACD reversal signals – began to flash across the long-end of the curve. At the time, the angst over a prolonged trade war with China caused a large number of market participants to regard the signal with a bemused calm.

This took place both in Europe & in US long-end yields (white line flipping above the red line).

The textbook variety of this signal is calculated by subtracting the 26-period Exponential Moving Average (EMA) from the 12-period EMA. The result of that calculation is the MACD line. A nine-day EMA of the MACD, called the “signal line”, is then plotted on top of the MACD line which can function as a trigger for buy and sell signals.

Suffice to say, for the better part of 2019 most global curves have been firmly entrenched in a “lower yields” paradigm for the trend community.

That may all be about to change.

Since that trend indicator flipped in late August, take a look at what futures open interest has done across 4 of the quintessential interest rate contracts available to your average, next door trend follower (I’m using TY, US, RX, UB – adjusting for rolls).

Now, that might not look like a lot until you begin to consider the duration implications of that open interest decline. Buxl contracts have an effective CTD adjusted DV01 of over 40 years – substantially longer even than the super-long issuance discussed by the Treasury (which, while it might have a 50yr maturity, would have a meaningfully lower effective duration).

This may just be the tip of the iceberg…

In $ adjusted duration terms – here’s what that works out to across just those 4 contracts: about $90 million per basis point in futures shedding. $90mm/bp is a tad over $100bn 10y Treasury equivalents.

Here’s the chart – note how much has gone thru just in the last week.

That is a monster move. We’ve seen a 20bp move in the last 4 days alone in US 30y yields. That’s a $1.8bn PNL swing just in these contracts (which are by no means the only liquid instruments outstanding).

By the way, $100bn 10yr notes is about what the US Treasury has pencilled in for their allotment of 10yr sales – for the rest of this year. The market just got it in less than a week.

If a justification for buying bunds at -80bps a few weeks ago was “duration-starved asset managers”, this is the equivalent of it now being stuffed down their throats.

References, Sources : Bloomberg, HFR Research, SocGen Hedge Fund Monitor, CME Group.


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