It's been a long time coming

7 min read

There was something missing in bond markets around the globe on Monday – that something was self-confidence, self-belief and, dare I say it, swagger. Part of this is no doubt a hangover from the bruising price action last week in which it was unusually easy to find oneself topped and tailed when market direction, if not sentiment, could turn on a sixpence.

I had run into many people over the weekend who asked why I looked so tired, and, having been told that it was largely the function of the volatile markets which had kept us on our toes all the time, immediately asked whether it was because of the general elections.

In time, I grew rather bored of trying to explain to them that the British elections were nothing more than fly droppings on the windscreen of the real world and that the rest of the globe had significantly larger fish to fry than the odd Sturgeon.

Something might have occurred last week which we have all been waiting for but which nobody could ever time, namely reaching the very final top of the bond market at the end of a run which began in 1987.

There had of course been a very volatile decade in bond markets following the oil shock of 1973 which led to hyper-inflation and 30-year Treasury yields peaking at over 15% – back then the only thing that counted was the long bond; nobody gave a fig for where 10s were trading – but by mid-1986 “the bond” (10s were and still are notes, not bonds) was back down at 7¼%.

From there it sharply backed up to around 9¾% in a move which triggered the Crash of ’87 but since then it has been on a one-way mission right through until January this year when it made its absolute low yield of 2¼%.

This decline of 750bp in 30-year yields has taken 28 years and it has, trust me, been neither straightforward nor predictable.

Fin de siecle feeling

Nevertheless, it would have been nice to have bought some of the US Treasury 9⅞% 11/2015 or US Treasury 9¼% 2/2016 at issue and to have had them littering every six months at that rate. Reinvestment, on the other hand, is not going to be fun. That said, there is quite clearly a “fin de siecle” feeling afoot.

Long bond yields have of course risen quite sharply from the January lows and are now at 3.07% and the 10s/30s curve has steepened from 55bp in mid-March to over 77bp this morning. How can it be that 10s and 30s appear to be living in such separate universes or is it that the long end is trying to tell us something which the intermediates don’t want to hear?

It has, as noted, taken 28 years for the long bond to shed 750bp so I think it is fair to suggest that it’s picking up 85bp in seven weeks might be little more than an aberration or the sign of a market looking for level at which it feels comfortable; it’s possibly something of a price-finding exercise.

There seems to be something different in the air, a sense that this really is the last throw of the dice, that we will not see these yields again in our lifetime

Even the recent lows in 10-year yields – 1.64% in January – remain a goodly chunk higher than the absolute lows of 2012 when we printed 1.39% and between then and now we have been all the way up to 3.00% and back down again and even the fabled 30-year bonds flirted with 4.00% at the end of 2013.

And yet, there seems to be something different in the air, a sense that this really is the last throw of the dice, that we will not see these yields again in our lifetime.

It might just be a passing phase, just like the other passing phases, and we might make new record low yields but the atmosphere in the marketplace isn’t pointing in that direction. Markets are tired and there is a notable lack of enthusiasm for being long. Hence, maybe, the rapid steepening of the 10s/30s. At 77bp, the curve is far, far away from its steepest – just two years ago we were at 125bp – although in term so a percentage differential between 10-year and 30-year yields, it looks poky.

Weak US first-quarter indicators, largely brought about by the harsh weather, have kept markets confident that the Fed can’t do anything hasty. The big debate is now whether that was combined with a normal cyclical down-turn which will persist or whether it was a one-off and whether Q2 will bring the strong rebound?

April employment figures were too bland to help anyone argue strongly either way. Bulls and bears both came out of Friday satisfied that their side of the debate had been fairly reflected. Thus we have to expect the Fed’s doves and hawks to be beating their respective drums while leaving markets to position the big guess.

There could now follow a few months of “up by the escalator and down by the elevator”. The only thing we know for certain is that the Fed’s next action will be to raise rates. The timing, however, is most probably as uncertain to the FOMC members as it is to us.

At this point I can’t see any reason to be aggressively piling on duration, other than as a trading position. I do, however, question the markets’ ability to absorb the risk when the reversal comes and the price action of the past week has shown what happens when the Street fears that it’s about to get buried.

Heavens help those who are caught long when the brown stuff really does hit the propeller. Thus, the steepening move should persist and I would warmly recommend to be part of it.

Meanwhile, our friends in Athens have today met their obligation to the IMF. If Greece were a registered company, its leaders would be close to facing charges of trading while in insolvency. Its arrears to other creditors now amount to €4.43 billion according to figures provided by the Finance Ministry.

How long can we let this nonsense persist? Is the political price of a Grexit now really going to be so much higher than the one which one day might be registered by non-Greek voters who question why the lie has been lived for so long and at their expense.

Anthony Peters