Today, we’ve just witnessed what qualifies as easily the largest 2wk move in the front-end of the Treasury market in 10+ years. So what happened, exactly? Here are 5 Things Every Trader Needs to Know About the Rates Market Move.
Two weeks ago, I wrote that the front-end of the interest rates curve was in serious trouble – given that policymakers were keenly aware of their deficiency in handling any selloff; more so than any point I could recall in my two+ decades of trading the interest rates market. Below I detail what I consider to be the biggest issues every trader needs to know about this rates market move.
1. BY THE NUMBERS
By any metric, this has been a substantial selloff. What’s happened at the front end of the curve perhaps deserves even more attention than 10yr note, however. That’s because of just how violent this has been relative to every other episodic selloff we’ve gotten in the last decade.
That’s not to say it’s been the only point where there’s been elevated volatility. The long bond has been under constant pressure & is now sitting within a few bps of the “taper tantrum” record. It’s a top 5 move in the last 10 years, easily.
2. VOLATILITY: IT HAPPENS ALL AT ONCE
…And what it takes is a catalyst. The conditions may be ripe for some time (valuations at extremes, a herd of investors crowded into a single, concentrated positions), but it takes a trigger to let it all come loose. So, while it might be convenient to ascribe these swings to different conditions in the long end vs the short end of the curve, it really was all the same trade. These conditions were set weeks ago & highly susceptible due to the inability for policymakers to enforce any kind of order in these positions, a dynamic I explained here:
3. THE MOMENTUM UNWIND
Expectations for global central banks were high, heading into last week. After all, the ECB was expected to deliver a massive stimulus package that included every bell & whistle in the central banking playbook. Any chance of a trade deal appeared dead. The goose seemed very much cooked.
But then the tide began to turn. Perhaps there was a chance after all that the ECB might want to save up at least one or two bullets in their arsenal rather than cutting 20bps & throwing the kitchen sink at the market before handing off the reins to someone whose latest resume line item included the single largest one-time investment in Argentina. Perhaps there was a chance the White House might not really want to head into the election season next year in the throes of an epic economic slowdown.
European rates were first to respond, but the US quickly caught up – selling off hard. Gone were the chances of a 50bp cut in September, the curve unwind was picking up steam after gaining untold numbers of adherents (including virtually every sell-side research report I read).
That triggered an unwind of truly epic proportions between equity momentum factor longs & shorts elsewhere (particularly value).
For more on that, refer to any of the excellent pieces written elsewhere across the financial universe over the past few days on the topic: here, here & here – for example.
4. HIDDEN CORRELATIONS
The problem was that so many of those longs in the Treasury market were also tied to some of the largest, most profitable positions in the world, a dynamic I explained here:
Indeed, in the smoking carnage that followed, it became clear that – yes, it was really all the same trade. The momentum vs value factor expression had become more tied to the 2yr Treasury than at any point in the last 5+ years.
The reason for this is due to a dynamic I explained here:
5. THE COUP DE GRACE
All that was left was for the ECB to under-deliver versus heady market expectations yesterday, and the coda was complete. The fact that this was not exactly the “bazooka” the market was hoping for has been well-documented & it’s a dynamic I explained here:
The unwind, as it’s continued, is now approaching about $50mm/bp of exposure – in bunds alone. It turns out that blindly buying an asset with an implied yield of less than -0.50% just doesn’t seem to hold up in the light of day.
How much further can this go? Well, there’s a lot of risk that was built up over the past month in long bond positions that were truly in excess of what was tied to traditional valuation metrics. That’s not saying it’s a bad thing, but it’s pointing out that you have to be realistic about what the value of an asset is that you’re buying. If it’s just a momentum vehicle, then you better be ready to get out of the way.
For Bunds, the simplest momentum indicators are clearly in control & pointing towards further weakness courtesy of the MACD sign-change. Longer term, we’re now retesting the 100dma – so if support doesn’t come here, it’s a long, long way down.
Unfortunately, bunds are by no means the only asset that’s facing this kind of momentum-driven onslaught. And if this doesn’t stop it, then it’s important to note that US Treasury futures are still quite far away from their respective 100dma. It’s not to say we won’t pass some key levels in yield along the way, but there’s every possibility we could overshoot to the higher side in yield (lower in price) in the same sort of way we did a month ago in the other direction.
SO, WHERE DOES THIS LEAVE US?
The September FOMC is next & could possibly provide some support – if indeed we get the type of dovishness that the market expects (and that equities require). One 25bp cut probably isn’t enough. There needs to be a commitment to more than just that, lower dots and/or a strong hint at an acceleration of other elements in the Fed’s toolkit. Otherwise, we could be in for a lot more than just a “pullback” in bonds.
References, Sources : Bloomberg, HFR Research, SocGen Hedge Fund Monitor, CME Group.
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