Back on Jan 20th, the WSJ’s Jon Hilsenrath penned a story suggesting the FOMC would continue their reduction in bond buying at yesterday’s meeting, “Next Cut in Fed Bond Buys Looms” to a mere $65 billion a month. This came shortly after a fairly ugly December jobs print and some mixed manufacturing data. Consensus was squarely in the camp that the prior month’s cut could remain the constant for the time being. So what of consensus??
I have been in the consensus that it would be impossible for bonds to rally in the face of the U.S. Federal Reserve, the largest buyer of U.S. Treasuries in the last 5 years, pulling back in a meaningful way. Since the May/June “Taper Tantrum”, when Treasuries began their descent from modern day highs, it has been consensus thinking that an epic bubble was bursting, the likes of one not seen since the real estate bubble of the last decade or the internet bubble of the 1990s. Make no mistake, the decline from the May highs, as measured by the TLT (iShares 20 year Treasury Bond ETF) down almost 20% closing at the dead lows of 2013 fit that consensus thought. But speaking to traders, I kept hearing the non consensus view that everyone and their mother was short bonds and the market’s positioning made some nervous.
Well, lo and behold, 2014 got off to a start that few expected. Most market participants focused on US equities would have thought that any sort of blip in our markets would have been the result of the economy dealing with higher rates induced by the Fed Taper. But all of a sudden, we got a little bit of a “dark-ish swan”, the rumblings of an emerging markets credit/currency crunch. And what did global investors do? Reach for the only crisis proven safe haven that exists in modern capital markets – U.S. Treasuries.
The move as some traders would say in Bonds was largely the result of “positioning” as they say, meaning everyone and their mother was of the same view, so it just took one participant to yell fire in a crowded theater, and boom!
The two year chart of the TLT could be quite telling though, especially if we see some sort of calm settle over global markets in the coming weeks. The ETF found resistance at its declining 200 day moving average (yellow) back in May, and Treasuries have been making a series of lower lows and lower highs ever since. Investors had started to “trade ahead” of the Fed.
While the break coupled with the Fed’s intimation of the scaling back of their years-long QE program was the prick that the bubble needed……until the trade became too consensus and was ground to a pulp into year end for window dressing purposes.
The six month chart below is quite fascinating, showing what has amounted to a near term double bottom: with a quick year to date rise, almost exactly to the point at which, on a purely technical basis it should have paused – its 200 day moving average (yellow):
For those who think the Fed re-takes center stage, and emerging market jitters die down a bit, the best trade on the board, on a near term basis could be a move back to the prior lows. I would also add that while implied volatility in almost every asset class has seen a nice spike of late as realized vol has increased substantially, implied vol on the TLT remains near multi year lows, making defined risk non-consensus-consensus trades a bit more palatable. Chart below of 30 day at the money IV in TLT makes this point. No matter what your view, TLT vol may be the cheapest on the board!