Treasury yields have been a one-way street lower since the June FOMC ‘all-in’ statement, plunging to record lows across the entire curve as hopes for the v-shaped-recovery and the boot of central bank repression stomp any brief spike in rates – despite a resurgent stock market.
How long can this massive decoupling go on?
Nomura’s Managing Director of Cross-Asset Strategy, Charlie McElligott, is worried the ‘reversal’ could be imminent.
A TACTICAL view we have been discussing says to fade this latest iteration of the UST rally into the local highs occurring now over the month of August’s strong bullish-seasonality for Rates, in order to set yourself up for a potential September / Q4 reversal weaker:
1. monster historical issuance release in September, in addition to…
2. pro-cyclical cross-asset “risk-on” seasonality btwn Aug31-Dec31 since ’94), as rich Rates / Duration could then likely / finally cheapen, with potential additional catalysts from…
3. more “low bar” / base-effect upside surprises on growth data if the “back to work” dynamic progresses (i.e. last night seeing China Export Growth +7.2% YoY in July, vs -2.0% expectation and 0.5% in June), as well as…
4. the ongoing release of more +++ Vaccine trial phase data and…
5. rolling “stimulus” releases / promises / expectations into the US Election and beyond
In turn, McElligott notes that a number of crowded cross-asset trades built upon the edifice of “low yields and flat curves” could see over-positioning / deleveraging risks on even just a short-term, but powerful, Bond selloff and / or steepening over the coming months:
Latecomers into Duration (and bull-flatteners) obviously at the core of this potential “reversal risk,” especially as we note the positioning-dynamic within systematic CTA Trend (99.3%ile $exposure to Bond allocation, rel 10 years)
Crowded Longs in Gold likely too get hit if we were to see real yields jump higher into a broader fixed-income selloff
Very popular “USD Shorts” similarly risk getting hurt if we see US nominal- / real- yields spasm higher, potentially squeezing the Dollar higher in sympathy, particularly as US new cases actually slow while European cases again pick-up
Longs in Nasdaq or Long Momentum factor (“Long Growth, Short Value”) in US Eq too would likely see reversal or relative underperformance pressure on a UST curve bear-steepening, with obviously the enormous overpositioning dynamic as a core accelerant
The ‘punchline’ being, it’s worth looking at “reversal” expressions / hedges out 3 months: Payers / Curve Caps (perhaps contingent on 30Y yields cheapening), Gold downside, US Dollar upside (EURUSD downside for instance) and US Equities Value & Cyclical sector upside Call Wing (hedging “Momentum / Sec Growth” longs)