Back in June, we warned that based on simple duration analysis, as a result of total market-traded US debt aggregates anywhere between $17 and $40 trillion – an all time high in terms of rate duration…
… traders faced massive mark-to-market losses of anywhere between $2.4 and $5 trillion should rates suddenly spike higher…. as they did yesterday, when as we reported the yield on the 10Y and 30Y Treasury jumped the most in percentage terms on record.”The U.S. 10-year yield was three basis points, or 0.03 percentage point, higher at 2.09 percent as of 12:09 p.m. in London, according to Bloomberg Bond Trader data. The yield jumped 20 basis points Wednesday, the most on a single day since July 2013.”
Today, Bloomberg has crunched the numbers after yesterday’s bond rout, and calculates that bond investors saw $337 billion – just over a third of a trillion – in losses on global bond holdings in a single day Wednesday “as Donald Trump’s election as U.S. president sparked concern his plan to boost economic growth will lead to a surge in inflation.”
The sharp, aggressive selloff, which continues today, spread into European and Asian bonds on Thursday, as traders caught up with moves in U.S. Treasuries. Speculation that Trump’s victory and a Republican-led Congress will lead to a wave of spending, spurred the likelihood that inflation will pick up in coming months, which would in turn erode the value of bonds. The decline in bonds saw Bank of America Merrill Lynch’s Global Broad Market Index drop by about 0.7 percent on Wednesday.
Having been stuck in NIRP hibernation for years, the market suddenly had to look up what this thing called “duration risk” is.
“Right now bonds are in some trouble,” said Barra Sheridan, a rates trader at Bank of Montreal in London. There is some concern that Trump “will be more fiscally expansionary, he will look to spend more money.”
European bonds were slammed too: the yield on 10-year German bunds climbed as much as eight basis points to 0.28 percent, its highest since May 2, while the yield on similar-maturity U.K. gilts rose for a fourth day to 1.35 percent, the most since June 23. Italian 10-year bond yields added nine basis points to 1.84 percent, and those on Spain’s climbed seven basis points to 1.35 percent.
As we explained yesterday, the reason behind the stock market rally and the yield surge is that bonds are falling as traders boost their inflation outlook and increase bets the Federal Reserve will raise interest rates. Bonds had initially risen on haven demand as the early vote count showed Trump set to win the election, before changing direction.
“Trumpeconomics implies a likely faster pace of Fed rate hikes next year,” said Robert Rennie, head of financial markets strategy at Westpac Banking Corp. in Sydney. “It is clear that this wave of populist vote has reflected, in part, dislike of tight fiscal, easy monetary policy. If we are now seeing a shift in the U.S., then that means markets will have to reprice this.”
As a reminder, Trump has pledged to cut taxes and boost spending on infrastructure by as much as $500 billion. His proposals would increase the nation’s debt by $5.3 trillion, the non-partisan Committee for a Responsible Federal Budget estimated. The government’s marketable debt has more than doubled under President Barack Obama, to a record of almost $14 trillion.
Once again, like every previous time when there is a bond selloff, strategists came out of the woodwork to predict a spike in yields, foreccasting between 2.5% and 3% or higher year end targets in 12 months. BMO’s Sheridan predicts yields on 10-year Treasuries can reach around 2.20 percent within a month. “The steepening trend is pretty firmly entrenched, I think it will continue,” he said.
Meanwhile, curves steepened aroudn the globe: the difference between yields on 10-year Treasuries and U.S. inflation-linked debt, a gauge of expectations for consumer prices, jumped to 1.87 percent Wednesday, the most since July 2015. The figure shows the market’s forecast for the annual average inflation rate over the period.
Finally, explaining the surge in the dollar, the sharp rebound in inflation measures means the Fed may have no choice but to act more swiftly to raise interest rates after holding off since increasing them from near zero in December 2015. There was an 82 percent chance they will move at their Dec. 13-14 meeting, up from 76 percent at the end of last week, according to data compiled by Bloomberg based on futures.
As for the massive MTM losses on bond positions, we look forward to see how bond investors will flow these through the P&L. Of particular interest, keep an eye on risk parity funds, which tend to have unpleasant days any time stocks soar while bond prices plunge.
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