For the record, Wall Street consensus has built a massive net short position across the entire Treasury bond curve. As bond investor Jeff Gundlach recently observed, these short Treasury positions were the highest in history and “could cause quite a squeeze.”
We agree.
We think Wall Street is on the wrong side of bonds.
For starters, we think the U.S. economy is going to slow starting in 4Q 2018. Our macro team’s predictive tracking algorithms for the U.S. economy and inflation are forecasting a slowdown.
This is important from an asset allocation perspective. If we’re right, Wall Street consensus may get caught offsides shorting Treasury bonds. In other words, market timing is important.
Here’s why that extreme positioning in Treasury bonds matters. Our research shows that—particularly in equities and fixed income—when Wall Street consensus positioning stretches to extreme levels, on both the long and short side, the returns of the underlying asset tends to move the other way.
Extreme short positioning in Treasury bonds could cause a short squeeze when a catalyst like U.S. growth slowing or a rollover in inflation tips the balance in the bond market’s favor.
It makes intuitive sense. For bond yields to continue higher from here, you’d need incremental bearishness among investors.
But, as we mentioned above Wall Street short positions in the Treasury market are at historic levels. Historically, when Wall Street positioning gets crowded the pool of investors that subscribe to the bullish or bearish thesis on the margin starts to dry up. From these overstretched levels, investors capitulate, and prices mean revert.
Bottom line: Wall Street’s historic short Treasury bond positioning is a tacit bet against our long Treasury bonds call. This non-consensus call has legs.
