No Mr. Bond, We Expect You To Die – Guest Post By Brian Kelly

by Dan August 18, 2014 1:57 pm • Commentary
On Friday we detailed how we were looking to “fade” the fear trade in U.S. Treasuries (read here: Name That Trade $TLT: Bonds – From Russia With Love) in the event of another spike and a re-test and failure of what we think is important technical resistance in the TLT.  We are trying to be patient.  My friend Brian Kelly, whom many of you know from Fast Money, and I have been debating the topic for the last few weeks. He has been correctly long TLT and 10 year Treasury futures but closed his bullish view today and is also looking for a good entry on the short side in front of the end of QE.  Here are Brian’s thoughts on the matter:
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Everyone is on One Side of the Bond Boat… Time for a Cool Change
Investors have been confounded by the stubbornly low interest rates in the US.  After all, if the economy is so good, why are yields so low? Long term interest rates are supposed to reflect the long run prospects for economic growth. In other words, the yield on the 10 year US treasury is purported to be a proxy for GDP growth.  With the yield approaching 2%, investors betting on a stronger economy may be questioning whether they have miscalculated.
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On August 15, 2014 the Philadelphia Fed released its Survey of Professional Forecasters (SPF) which indicated that economists are expecting real GDP will grow 3.1% in 2015, 2.9% in 2016, and 2.8% in 2017. So why is there a disconnect between the 10 year yield and the GDP forecast?  Notwithstanding the inability of anyone (let alone economists) to predict the future, the difference appears to be the result of stagnant wages.
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On the same day the SPF was released, the Chicago Fed published a paper titled “Understanding the Relationship between Real Wage Growth and Labor Market Conditions”.  The conclusion of the paper was that wages were not increasing due to the ‘slack’ in the economy. In the fact, the researchers found a strong relationship between the increase in the number of people marginally attached to the workforce and stagnant wages.  This finding makes intuitive sense. In a competitive market, if there are an abundance of laborers that are only working part-time due to economic conditions it follows that they will be willing to ‘sell’ their labor at a lower ‘price’.  In other words, if you have been working part time and finally get the chance for a full time job you will probably be more likely to accept a lower salary in exchange for the permanence of full time employment.
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So why do we even care? And why did I drag you into my econo-dork world?  Because the Kansas City Fed hosts its annual Jackson Hole Symposium this week.  This meeting of the economic superpowers was used by Ben Bernanke to launch QE2 among other notable policy announcements.  The subject of this year’s gathering is…surprise, surprise…”Re-Evaluating Labor Market Dynamics”.
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This seems like a slam dunk for a dovish message from Janet Yellen this week…not so fast cowboy…the bond market has been anticipating this for months.  Back in April two former central bankers, David Blanchflower and Adam Posen released a paper that illustrated the labor market was weaker than the Fed was anticipating. Titled “Wages and Labor Market Slack: Making the Dual Mandate Operational” the authors concluded that those who have left the labor market should not be counted as gone forever.  Not surprisingly the bond market began to ingest this information and yields broke down after April 15.
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It was also around this time that the Commitment of Traders report showed that asset managers were covering short positions in Ten Year notes. In fact, in April 2014 asset managers recorded the largest short position in the last twelve months. As of last week, those asset managers are as close to a neutral position as they have been since December 2013.
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What this all means, is that unless money managers really believe the economy is headed toward another recession, yields have probably bottomed.  Whether this is a terminal bottom or not is impossible to tell, but with everyone on one side of the boat the odds are in favor of a rally in rates/drop in bond prices.
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You can follow Brian Kelly @BrianKellyBK and his website www.BrianKellyCapital.com