Bond Buyers are hungry and not just for Argentinian sovereign debt
With the Federal Reserve hiking interest rates, economic growth picking up, money flooding into equities and monetary policy normalizing around the world, traditional financial theory dictates that bond yields should be rising.
However, precisely the opposite is currently happening. Indeed, the divide between the Fed and bond market is getting wider by day. Fixed income traders have pushed the yield on 10-year Treasury notes down to 2.17% down from 2.63% in March. According to a recent opinion piece on Bloomberg, this move is traders trying to “force the central bank to back off its hawkish stance.” What’s more, “the current levels of long term yields suggest traders have all but erased any remaining caution for further tightening in 2017. And they show complete disregard for the Fed’s plans to hike in 2018 and 2019.”
Traders’ lack of regard for the Fed’s actions are being blamed for the move lower, but the question of exactly who is to blame remains unanswered.
In a research note published at the beginning of this month, JPMorgan’s Nikolaos Panigirtzoglou considered the move and arrived at the conclusion that the usual suspects of hedge funds, risk parity, and CTA funds are to blame. Specifically, in the note he writes that during the first week of June “The spec of position on the 10yr UST futures contract moved to even higher, i.e. even more overbought, levels than at the beginning of May,” as “hedge funds appear to have shifted to an even more extreme long duration position.” CTA trading on the yield curve also shifted the “spec position on the 10ys UST futures contract…to even more extreme overbought levels, leaving the intermediate sector of the UST curve vulnerable to a selloff.”
Bond buyers not selling anytime soon
Bank of America’s credit researchers believe that this trend is unlikely to end anytime soon as cash on the sidelines rotates back into credit. According to the bank’s June European credit investor survey, even though investors have moved “longer post the French elections, credit overweights still remain noticeably below the post-Lehman average, and few, if any, sector positions look worryingly crowded at present.”
Bond buyers are showing no sign of slowing down with high-grade fund inflows surging during the second week of June to the eighth highest ever recorded level on the back of lower political risk. Still, the bank’s credit survey shows that the major worry for credit investors remains “bubbles” with 33% of respondents indicating that they were worried about this factor for the June survey.
17% of respondents also indicated they were worried about the level of supply coming into the market, up from 0% during April. Bank of America’s analysts are also concerned about this. They’re particularly worried about the supply/demand dynamics of the European credit market as inflows remain robust and supply declines:
“High-grade fund inflows have surged (8th biggest inflow ever) on the back of lower political risk, leaving investors with above-average cash positions, just at a time when new issuance is slowing compared to May’s hectic pace.”
But with credit investors seeing few headwinds on the horizon, and with 22% of the survey’s respondents seeing no alternatives for high yield credit in Europe, it seems the bond rally still has further to run:
“With credit investors struggling to pin down the big bearish risks for markets, we think they are rapidly coming to the conclusion that there is little to hold corporate bonds back from rallying.”