SocGen: “What Bond Bear Market? I'll Believe It When TIPS Are At 1%…”

Original post

When the 10Y rose above 2.50% yesterday (and spiked another 10 bps today on the China TSY buying news), various pundits emerged, calling for an end to the secular bull market in rates, starting with Bill Gross ,who said  that the “bond market was confirmed today”, followed by Jeff Gundlach  who said that while Gross is early, it will only take 2.99% on the 30Y to break the trendline.

sdf

Then, this morning it was the turn of Mint Partners’ Bill Blain to declare the onset of normalization and that “this was the moment we’ve all been waiting for.” And the WSJ even trotted out a staple headline we have seen every year since 2010: “Investors Prepare for Inflation as Bond Yields Rise.”

Maybe, but it is just as likely that this is the old headfake which we see every single year when there is a brief inflation scare which is then promptly swept under the relentless deflationary (almost entirely from a wage standpoint) tide.

To be sure, not everyone is buying the “bond bear market” thesis.

In a note released this morning, SocGen’s FX strategist Kit Juickes observes that “the (bond) bears are calling for a picnic” but he is skeptical that this is the time, and here’s why: “I’ll believe the bond market has turned when 10year TIPS yields have broken 1% (and nominal yields have broken 3%). That’s where yields ran out of steam in the 2013 Taper Tantrum, as the sell-off in asset markets (notably in EM), prompted the Fed to soften its tapering stance and change its forward-guidance.”

What followed then was the demise of term premium in bond yields and much lower estimates of equilibrium real interest rates.

And yet, not even Juckes is willing to stand in the way of rising yields:

“I don’t think there’s enough inflation, or indeed enough growth, for the Fed to risk a proper market tantrum, so I fully expect them to stand in the way of a meaningful move higher in yields, but the big question for 2018 is, without a doubt, whether there’s anything central bankers can do to prevent markets reacting to balance sheet normalisation (other than just not do it).”

Should Gundlach be correct, and 10Y yields explode higher once 2.63% is breached, we may find out in the immediate future.

Meanwhile, keep in mind that Juckes was the strategist who correctly pointed out last September that it was China’s intervention in the FX market on September 8 when it scrapped reserve requirements and allowed a surge in the USDCNY (and dollar in general), sending 10Y yield higher.  We summarized his take as follows:

To summarize, if Chinese reserve accumulation drove yields and the dollar down, supporting higher-yielding currencies in general, then the previously discussed dramatic reversal by the PBOC on September 8 marked the turning point. Or as Juckes puts it, “policy was changed, signalling the end of Yuan appreciation, the end of the rally for Treasuries, high-yield currencies and the euro. When USD/CNY stops rising, buy EMFX and EUR/USD again?”

And while we agree with Juckes that bear market calls are premature, we are far more interested what he will have to say about today’s news of the day which is clearly China’s explicit warning to Trump to stop threatening wage war, or suffer the loss of the biggest foreign buyer of US Treasurys, the mere hint of which sent 10Y yields to the highest since March.

Here is Juckes’ entire note:

The (bond) bears are calling for a picnic

Bill Gross has declared a bear market in bond-land and Jeffrey Gundlach has proclaimed the start of an ‘era of quantitative tightening’. Yesterday I pointed out that the turn higher in USD/CNY last September was accompanied by a sharp rise in Treasury yields, but the collective wisdom is that this bond sell-off is made in Japan rather than China. More prosaically, it’s down to optimism about US growth, concern about inflation ahead of Friday’s CPI data, lack of demand ahead of this evening’s auction of $20bn in 10year Notes; and (last but definitely not least) concern that global central bond-buying is about to go into reverse. ‘Fed balance-sheet reduction tantrum’ isn’t nearly as snappy as ‘taper tantrum’ but still….

I’ll believe the bond market has turned when 10year TIPS yields have broken 1% (and nominal yields have broken 3%). That’s where yields ran out of steam in the 2013 Taper Tantrum, as the sell-off in asset markets (notably in EM), prompted the Fed to soften its tapering stance and change its forward-guidance. What followed were the demise of term premium in bond yields and much lower estimates of equilibrium real interest rates. I don’t think there’s enough inflation, or indeed enough growth, for the Fed to risk a proper market tantrum, so I fully expect them to stand in the way of a meaningful move higher in yields, but the big question for 2018 is, without a doubt, whether there’s anything central bankers can do to prevent markets reacting to balance sheet normalisation (other than just not do it).

Intriguingly, this jump in US yields isn’t doing anything to help the dollar yet. As well as JPY, AUD, NZD and CAD may have more to gain from policy normalisation. I’ll work on that for tomorrow’s FX Weekly. The divergence between relative real yields and USD/JPY is striking and a taste of what will happen when the BOJ starts normalising ($/Y <100). We’ll probably see 111 before relative real yields re-assert their authority. GBP faces a challenge from manufacturing and trade data today and Bullard and Evans are today’s scheduled Fed speakers.

d