THERE WERE A few things missing in bond markets around the globe last week – self-confidence, self-belief and, dare I say it, swagger. Partly this was no doubt a hangover from the bruising price action of recent weeks in which it was unusually easy to find oneself topped and tailed and when market direction, if not sentiment, could turn on a sixpence.
I had run into any number of people over the post-UK election weekend who, when asking why I looked so tired and having been told that it was largely the function of the volatile markets, immediately asked whether the volatility was a function of the 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 in May 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 that 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 7-1/4%. From there it sharply backed up to around 9-3/4% in a move that triggered the Crash of 1987 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 2-1/4%.
This decline of 750bp has taken 28 years and it has, trust me, been neither straightforward nor predictable. Nevertheless, it would have been nice to have bought some of the US Treasury 9-7/8% 11/2015s or 9-1/4% 2/2016s 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.
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% and back down again – even the fabled 30-year bonds flirted with 4% 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. There is, to put it another way, a “fin de siecle” feeling afoot.
It might just be a passing phase, just like the other passing phases, and we might soon 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 curve.
The only thing we know for certain is that the Fed’s next action will be to raise rates
WEAK US FIRST-QUARTER indicators, largely brought about by the harsh weather, have kept markets confident that the Fed can’t do anything hasty. So the big debate is now whether that was combined with a normal cyclical downturn that will persist, or whether it was a one-off and whether the second quarter will bring the strong rebound.
April employment figures were too bland to help anyone argue strongly either way. 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.
I WAS IN contact with a Wall Street equity strategist during the week who was watching yields with significant interest. Like many equity players, he trusts the direction of bonds as an indicator of things to come more than he does that of stock markets. He places great trust in the correlation of bond yields and the Employment Cost Index, which he believes to be more pertinent to Fed thinking than any other number emanating from the labour market. The ECI is rising faster than bond yields and he foresees a further upwards adjustment of intermediate rates.
He is also, incidentally, watching consumer confidence and the development of stock prices in the consumer discretionary sector – Apple works as a helpful proxy – where he worries about big overweight positions. As consumer confidence continues to fade, he’s expecting some of these to be unloaded and, in light of rising bond yields, a significant correction in US equity markets to follow. I introduced him to the chart with rising yields throughout 1987 with the subsequent crash – he was nodding so vigorously, I could even hear it through the phone.
The strategist in question comes from a foreign exchange background and is therefore used to taking a very disciplined approach to observing developments across asset classes and seeking trigger points. He was and is feeling deeply uncomfortable.
At this point in time, 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. Heaven 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 being part of it.
