Relentless rally in bonds makes traders wonder what they missed

Over the last few months, Priya Misra considered that the bond rally was mainly due to technical factors such as the positioning in the market which would soon be reversed.

On two occasions, the global head of rate strategy at TD Securities has recommended that her clients bet against the rise in Treasuries, expecting strong economic momentum and high inflation to drive up yields. On two occasions, she was forced to drop the appeal as ties continued to win.

Now she wonders if lower yields indicate cracks in the global economy and the possibility that the Federal Reserve is making a policy error by signaling plans to cut stimulus faster than investors and traders. deem appropriate.

“We can all see why techniques can take us away from fair value for a while,” Misra said. “But if he stays there for two months, that’s when you start to think that it must be something fundamental here, or a big asset allocation here.” It’s not just the positioning because no one is erasing it. It’s a strange market.

The bond rally initially dismissed by investors and analysts as having little fundamental support has proved to be persistent. Yields on 10-year Treasuries are on track to decline for four consecutive months, something they have not done since the start of the pandemic. At around 1.3%, they fell from a more than a year high of 1.77% at the end of March, partly amid the rise of dangerous Covid-19 variants.

Additionally, 10-year real yields, considered the market’s purest reading on growth because they exclude inflation, have come back below minus 1% and around their lows since February. The slide means next week’s auction of 10-year inflation-protected Treasury securities could generate a record yield.

Disconnection from the market

The latest drop in long-term borrowing costs occurred even after reports this week showed galloping inflation and higher than expected retail sales. The apparent disconnect has left some market players scratching their heads.

“Bond traders were worried about inflation,” said Ray Remy, co-head of fixed income at Daiwa Capital Markets America. The “somewhat alarming” inflation figures and the “continuing” Treasury offer support the widely held view that long-term yields are too low, he said.

But for him, the Fed’s bond purchases, along with its forecast and the advantage of US yields over Europe and Asia are the main driving forces behind lower yields.

Among other possible explanations, short hedging has attracted a lot of attention – essentially market participants bailed out on reflation bets. JPMorgan Chase & Co.’s latest weekly survey showed 23% of customers were selling net Treasuries, up from 33% in mid-June, which was the largest short bias since 2017.