Bond Market Is On The Cusp Of A QT Tantrum

As attention moves to the upcoming Jackson Hole Economic Symposium (aka global central bank meet up) it’s worth taking a look at a couple of developments in monetary policy and bonds markets.  The main reason, as I will explain, is that there is the very real prospect of a repeat of the “taper tantrum” of 2013… a QT tantrum, if you would.

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We looked at the issue in detail in the latest weekly report, alongside a preview of Jackson Hole - noting the key economic developments that point to a global trend-change in monetary policy.

The chart of interest is the US 10-year government bond yield, shown alongside bond market implied volatility (or the 'VIX' of the bond market).

Cusp Of A QT Tantrum

Bond market implied volatility has crunched back to levels last seen immediately prior to the 2013 taper tantrum.  Similarly, speculative futures positioning is now stretched to the long side, and assets under management in income oriented funds have ballooned to record levels.  So looking at the market alone, it feels vulnerable to a shock.  That is, the bond market looks complacent and overbought.

Think then, about the prospect of the Fed announcing Quantitative Tightening (QT)... i.e. "balance sheet normalization".  The Fed announced plans for balance sheet normalization earlier this year, and with a couple of rate hikes now under its belt, the Fed will be looking to activate these plans, and September would be an ideal juncture - with Jackson Hole providing an ideal forum to discuss and flag its imminent arrival.

Something this well flagged you think wouldn't upset markets too much, and the Fed has been consulting heavily with asset managers and financial market participants about its plans for balance sheet normalization.  So on the face of it you wouldn't expect any financial stability concerns... indeed, in the BAML fund manager survey, and our own surveys on Twitter, the majority of respondents expect QT to be either a non-event or even a risk-on catalyst.

So maybe Janet Yellen flags QT at Jackson Hole, and then maybe the FOMC pulls the trigger on it in September. And maybe the market shrugs it all off.  But that last maybe seems the least likely. With a complacent and overbought bond market, and relaxed attitudes towards Fed balance sheet normalization, whether it's Jackson Hole or the September FOMC, don't count out the possibility of a QT tantrum.  Also, if it happens it would come at a time where equity markets look vulnerable and the currency is at a key moment.

This article originally appeared as a submission at See It Market

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Article by Callum Thomas, Top Down Charts




About the Author

Top Down Charts
Topdown Charts: "chart driven macro insights" Based in Queenstown, New Zealand, Topdown Charts brings you independent research and analysis on global macro themes and trends. Topdown Charts covers multiple economies, markets, and asset classes with a distinct chart-driven focus. We are not bound by technical or fundamental dogma, and instead look to leverage any relevant factor to capture the theme. As such, here you will find some posts that are purely technical strategy, some that just cover economics and data, and some posts that use multiple inputs to tell the story and identify the opportunities. Callum Thomas Head of Research Callum is the founder of Topdown Charts. He previously worked in investment strategy and asset allocation at AMP Capital in the Multi-Asset division. Callum has a passion for global macro investing and has developed strong research and analytical expertise across economies and asset classes. Callum's approach is to utilise a blend of factors to inform the macro view.