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Unstoppable Negative Yields Suddenly Become Stoppable

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Publié le 21 septembre 2019
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Snapback Bloodletting in the Overripe Bond Market.

This is the transcript from my podcast last SundayTHE WOLF STREET REPORT:

OK, so we’ve got ourselves one heck of a snapback in government bond yields, not just in the United States, but globally. And the negative-yield mongers that were out there for months, preaching their book and prophesying near-zero or negative yields even for the 10-year US Treasury – this includes hedge funds with algo trading strategies – they’re suddenly facing steep losses on their highly leveraged bets because yields have snapped back viciously.

The 10-year Treasury yield closed on Friday at 1.90% [Sep 13]. This was up 43 basis points, or close to half a percentage point from eight trading days ago, from September 4, when it was 1.47%.

When bond yields rise, bond prices fall by definition. For the 10-year yield, a 43 basis-point jump in eight trading days is massive. It was right there with the other three snapbacks since the Financial Crisis, and proportionately speaking, it was the largest in the data that I looked at through 2007.

But none of these snapbacks ended after eight days. They continued on average for five months, with 10-year yields rising 120 to 170 basis points. A classic snapback like this would nearly double the current 10-year yield.

How massive was the snapback over the past eight days, compared to the prior ones? Ok, let’s see:

  • It was just about as massive as during the last snapback in 2016, when during the worst eight-day period, yields had risen 46 basis points.
  • It was just about as massive as the 46-basis point jump during the worst eight days of the Taper Tantrum in 2013.
  • And it was nearly as massive as the 58 basis-point jump during the worst eight days in late 2010.

These vicious snapbacks are not uncommon. They occur when some clamorers in the market manipulate up bond prices as hard as they can, and thereby manipulate yields down, and create a lot of momentum behind the 10-year Treasury, and then suddenly, they run out of steam and they try to unwind their complex bets, and bond prices fall and the yield snaps back.

But the current snapback is proportionally-speaking steeper than the others, given how low the yield was in early September when the snapback began. In percentage terms, the yield jumped by 29% in eight trading days — in other words, it’s almost a third higher than it was eight days ago.

  • In 2016, the worst eight-day snapback maxed out at 25%.
  • In 2013, during the Taper Tantrum, the worst eight-day snapback maxed out at 21%.
  • In 2010, the worst eight-day snapback maxed out at 20%.

10-year yields lumber down an uneven staircase, but when a snapback occurs, they go up by express elevator. This was a vicious snapback by any measure – and a well-deserved one because these negative-yield momentum folks had set themselves up for it.

These yield snapbacks are so essential and so inevitable after these mega efforts to push yields down that even I knew there would be one – and I said so in my podcast on Sunday, September 1, with the transcript being published on September 4.  It’s not that I knew that the snapback would start a couple of days after I published my podcast. I didn’t. But snapbacks are common, and they’re inevitable, and the market was totally overripe for one. And the most overripe markets get the juiciest snapbacks.

But the thing is, these classic snapbacks don’t last eight days. They last for months.

The snapback that started after the 10-year yield had dropped to a historic low of 1.37% in July 2016, lasted five months through the end of the year, pushing the yield up by 120 basis points.

The snapback of 2013 – the Taper Tantrum – started in May and lasted five months into September. It pushed the 10-year yield up by 130 basis points.

The snapback of 2010 started in October and lasted over five months into early March 2011. It pushed the 10-year yield up by 170 basis points.

If this snapback follows the pattern of prior snapbacks, we’re looking at something like five months of rising 10-year yields, more gently than in the past eight days, with sharp ups and downs, but rising overall, with the yield going to something like 2.7%. And that may be the optimistic scenario.

Why optimistic? Because never before has there been such a huge massive and idiotic bond-market bubble globally. These bubbles can last a lot longer and can go a lot further than anyone with a rational mind can explain, but they don’t last forever — never have, never will. Along the way, the US yield curve would un-invert, and steepen, and it would start to look normal-ish again.

Globally, during the peak of this negative-yield craziness at the end of August, there were $17 trillion – trillion with a T – in negative yielding bonds outstanding. Meaning these bonds traded at such a premium over face value that if you bought those bonds at the time and held them to maturity, which might be 10 or more years, and you add up all your coupon payments plus what you get for the bond when it’s redeemed, which is face value, you’d lose money.

And this is just the nominal loss. Considering that there is persistent inflation, even if it is not huge, the real loss adjusted for inflation over this long a period is far larger. It’s absurd to hold “investments” like this.

Folks buy these absurd instruments basically for three reasons:

One, you have to buy them because you’re a pension fund or an insurance company, or a bank, and you have to fulfill rules and regulations that require you to hold a certain percentage of your assets in your country’s government bonds, no matter what the yield, and no matter how it will wipe out your beneficiaries.

Two, you want to sell the bonds at an even lower yield, and therefore even higher price, shortly after buying them, to an even greater fool.

Three, you want to use them for complex, highly leveraged, highly risky bets whose real risks no one understands, or wants to understand, and for which you want to use other people’s money, and when these bets blow up, they will take down squadrons of hedge funds along with other people’s money.

Back at the end of August, when there were $17 trillion of negative yielding bonds, they included about $1.2 trillion in corporate bonds. I’m not sure if that was the moment of peak absurdity – but it might have well been.

In Europe and in Japan, yields have snapped back too. The German 10-year yield snapped back 26 basis points, from a negative -0.7% at the end of August to a negative -0.44% on Friday. Maturities of 25 years or higher have positive yields once again. The 30-year yield closed on Friday at a positive 0.13%. Just a couple of weeks ago, the German government attempted to sell 30-year bonds with a negative yield, at an auction that “failed.” The Japanese 10-year yield snapped back 13 basis points from a negative -0.28% to a negative -0.15%. Maturities of 14 years or longer have positive yields.

That $17 trillion of bonds with negative yields at the end of August has by now shrunk to about $12 trillion. That’s still absurd, but it’s $5 trillion less absurd than it was two weeks ago.

In the US, if the 10-year yield follows prior snapbacks and heads up toward 2.7% over the next five months or so, it would accomplish all kinds of things, including it would fix the yield curve. As the 10-year yield rises a little above 2%, the yield curve would begin to un-invert. And as the 10-year yield rises further, the yield curve would steepen.

The yield curve has been the hottest topic since last year, when it threatened to invert before it inverted partially this year. In the past, it was when the yield curve un-inverts that problems arise because the bets have all been placed on one side of the boat, on it inverting more deeply. So, there will be bloodletting among highly leveraged bets.

Mortgage rates have already jumped over the past eight days, along with the 10-year yield, though they remain extraordinarily low. 30-year fixed rate mortgages for prime borrowers were still quoted on Friday in the 3.8% neighborhood, with FHA and VA loans lower than that.

Snapbacks in the bond market can get messy – not for the overall economy, but for some financial players with big, complex, highly leveraged bets whose risks no one really tried to understand.

The US economy can digest a 10-year yield in the 3%-plus range without much trouble. Sure, home prices in some markets would slither lower, but they shouldn’t have risen that far in the first place, and the decline would just correct for overexuberance. Lower prices would be a boon for homebuyers.

But for those gambling folks… If the 10-year yield goes back where it had been last November, it would be over double the yield of two weeks ago, and folks risking the farm with a bet that counted on a yield closer to zero, which they have been promoting loudly for months, might just lose the farm.

You can listen to and subscribe to my podcast on YouTube.

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