I last wrote on this topic of Crowded Trades (when, mostly hedge funds, are all positioned the same way) on Feb 8th (highrockcapital.ca/pauls-blog/revisiting-government-bonds-and-crowded-trades).
I thought today would be a good day to revisit and to see the effect of a crowded trade. The crowded trade to look at, again, is the US 10yr Treasury bond (futures) short positions for non-commercial holders. Recall that non-commercial means, non-businesses that would naturally need to hedge against higher interest rates, so, therefore, non-commercial are largely seen as speculators/hedge funds. And being short means that the short seller short sells them at a high price (low yield for bonds) and hopes to cover them at a lower price (higher yield for bonds). Here is the chart (as of Feb 28th) on the short interest in US 10yr bond futures:
This is the most short the market has ever been on 10yr US Treasury bonds. Ever!
Onto Employment. By all/most measures, as Scott pointed out this morning after the Employment data, (highrockcapital.ca/scotts-blog/employment-unemployment-data-will-not-stop-us-federal-reserve-from-raising-rates) the Employment situation in the USA (and Canada too) appears to be improving. Most notably I would add that up until this February report, the quality of the employment gains in the US have been lower quality jobs like in the service industry and retail. Today, however, we found that the bulk of the hirings were in manufacturing (higher paying jobs). The reason why this is all so important for the bond market is the specter of inflation. Should the employment picture look like there are more jobs, better paying jobs, and higher wages, the Federal Reserve will get nervous about inflation and move to hike rates faster.
So with today's strong employment report, one would have thought that bonds would have been hit pretty hard because after the report, some economists increased their calls for further rate hikes this year. Not good for the bond market, right? Maybe, but what happened? Have a look at the US 10yr Treasury bond in yield over yesterday and today:
Hard to see in the graph above but the yield closed at roughly 2.61% yesterday and today it is at 2.59% (now 2.58% at time of writing)...after such a strong employment report and increased odds of further rate hikes?? How can this be...rates should have continued on their recent one week path to higher yield levels. But they didn't. Why not?
Answer? - Refer back to the first chart. Everyone is short, and record short at that. They all want to take profits at higher yields. And I could show another chart that shows that "longs" or those holding US Treasury bonds are at an all-time low (these longs could be seen as mutual fund portfolios etc)
One thing I learned back in 1990 from a guy I worked with at Merrill Lynch (and eventually took over his trading job there) was - "Sometimes you don't know what the event will be to cause a market to move but if everyone is lined up on one side of the boat, the path of least resistance becomes the opposite of what everyone is expecting" - J Scott Tomenson. (27 years on, and I will never forget that quote (paraphrased, to be honest).
So what do we do at High Rock with this knowledge? Our government bond exposure was largely trimmed last September. Government bonds performed very well for us for about 1.5yrs but things changed, and so did our position. We added a small portion back two weeks ago when correlations changed in our favour. At this stage, we are debating buying some more government bonds back but we are trying to be selective with our entry points because going against the grain means we need to decipher if this is just a "short covering bid" which will be only temporary, or if it a longer-term change, caused by some event we just cannot predict.
Sometimes, you just don't know what the event will be.