Treasury yields are breaking multi-year records as bondholders across the board sell their positions, and yields on 10-year U.S. notes climbed as high as 2.86% after taking in a 25.5 bps increase over the last week. This is the closest they have gotten to the last high reached in July/Aug 2011 when the Eurozone crisis was at its worst. Yields on 30 year U.S. notes are also as high as 3.87% today, as it seems more and more investors are convinced that the fateful Taper will materialize in the upcoming September meeting of Federal Reserve.
Bond market spooked by Larry Summers
Andrew Lapthorne of Societe Generale writes in his note that the rapid sell-off in bonds seems to have gone unnoticed by equity markets. Lapthorne says, “Equity volatility continues to trade at reasonably low levels, while corporate bond spreads continue to head lower.”
The interesting thing to note here is that the sudden volatility in bond markets has not come in response to any major market news. Nomura’s George Goncalves notes that the reaction is more likely driven by Larry Summers, one of the potential new Fed chairs [Joe Weisenthal, Business Insider]. Summers is expected to be a more hawkish Fed chief, Goncalves said:
“The biggest risk to the bond market and our tactical bullish trades in our model portfolio is the combination of tapering fears and the election of a more hawkish Chairperson. In such a scenario we wouldn’t be surprised that investors just sit on the sidelines and see how high rates can go if a hawkish Fed nominee is announced, with an overshoot meaningfully above 3% possible.”
Analysts seem to have widely divergent views on how markets are going to act going forward—Goncalves thinks that stock markets will be under more pressure than bonds if yields continue to rise at this level, and the latter becomes a competitive advantage at high yields in contrast with the views of SocGen’s analyst.
Hilsenrath’s terror driving yields low?
RBC Capital Markets’ John Briggs opined that the sell-off in treasuries witnessed on Friday was possibly because, “Friday’s anticipated Hilsenrath article was not dovish, as foretold”. Hilsenrath wrote over the weekend, “Fed could become more fractious when Mr. Bernanke departs, with important implications for the central bank, markets and the economy.” While Hilsenrath’s latest WSJ piece was not exactly hawkish, he decidedly brought less ‘good news’ for long bond holders than it was expected. RBC holds tactical longs in treasuries with a stoploss at 2.85% which they intend to stick to, so they are probably unloading the trade right now.
The record climb in bond yields was predictable as sell-off in the bond markets took the worst shape over the last week. Considering hedge fund positions as a benchmark, net short positions in 10-year treasuries tripled on last Tuesday, according to CFTC. Hedge funds currently hold their largest bearish bets against the treasuries in over 12 months, with 66,432 short contracts in 10-year notes. The aggressive expansion in short positions has been going strong in 2-year and 30-year notes as well.