Tales of the Long Bond Pain Trade

Takeaway: The buy-side is far from having capitulated on the short side of the long bond. We think they most likely will in the coming weeks & months.

Consider the following return figures:

 

  • iShares 20+ Year Treasury Bond ETF (TLT): +2.9% WTD, +3.1% MTD, +8.6% QTD and +24% YTD
  • Vanguard Extended Duration Treasury ETF (EDV): +3.9% WTD, +5.1% MTD, +14.2% QTD and +40.8% YTD
  • iShares National AMT-Free Muni Bond ETF (MUB): +0.3% WTD, +0.3% MTD, +0.5% QTD and +6.3% YTD

 

Now consider the most recently reported net speculative position of -214.8k futures and options contracts on 10Y Treasury notes. On a TTM Z-Score basis, that’s the most net SHORT the buy-side has been of the long bond since the week ended March 23rd, 2012.

 

Tales of the Long Bond Pain Trade - 1

Source: Bloomberg L.P.

 

It’s worth mentioning that the long bond rallied hard on that signal; from late-March of 2012 through late-July of that same year, the 10Y Treasury yield plunged -86bps to its all-time closing low of 1.38%.

 

Tales of the Long Bond Pain Trade - 2

Source: Bloomberg L.P.

 

That current setup in the bond market rhymes with investors broadly continuing to anticipate “escape velocity” and a rate “lift-off” over the NTM – even if only a modest tightening: DEC ’15 Fed Funds Futures are pricing in a mere +25bps rate hike by the end of next year.

 

Tales of the Long Bond Pain Trade - 3

Source: Bloomberg L.P.

 

All told, the buy-side hasn’t capitulated on the short side of bonds yet.

 

They most likely will.

 

And when they do, you’ll be able to book some nice gains by selling into their mass short-covering – that is, of course, to the extent you’ve been following our recommendation to be long of long-term Treasuries and munis [and defensive equities that resemble this long duration exposure].

 

Happy holidays!

 

DD

 

Darius Dale

Associate: Macro Team


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