Barn Burner 30-Year Auction Shows Some Yield Still Beats Negative Yields

Do you hear that? It’s a big sigh of relief.

Yesterday, we walked you through a disaster of a 10-year Treasury auction. Lowest bid-to-cover since March 2009, lowest indirect takedown since January of last year, and on, and on.

We also explained why you should care. Negative yields in Germany, Switzerland, and Japan have driven voracious demand for US paper which looks attractive by comparison. What do you get when you combine the “anything but negative” bid and a stubbornly dovish Fed message? This:

That’s a pretty remarkable rally. And it’s made even more remarkable when you contrast it with what stocks have done:

Obviously, there’s a disparity there that either needs to self-correct or at least explain itself. How could the safe haven bid be so strong while stocks make new highs? What does this say about the equity-risk premium (ERP)? Should we even bother looking at it anymore, or have artificially low yields made it meaningless?

All good questions, to be sure. While stocks are almost unquestionably rich, bonds are likely even more so. SocGen, for instance, thinks 10s should be trading around 1.90. So when indirect takedown came in low on Tuesday, the question became this: is the foreign bid drying up? Or, put differently, have yields finally come down too far?

We got some indication that the answer is “no” with today’s 30-year auction. That’s why we said at the outset that there’s a sense of relief after what was a real barn burner. Here are the highlights via Bloomberg:

  • 30Y AUCTION 2.48 BID-TO-COVER HIGHEST SINCE SEPT.

  • 30Y AUCTION 68.5% INDIRECT AWARD HIGHEST ON RECORD

  • 30Y AUCTION 23.1% PRIMARY DEALER AWARD LOWEST ON RECORD

“Boom.” That’s about the only thing you can say about that.

But before anyone goes and gets too excited about frontrunning new lows for US yields, consider the following from Deutsche Bank, who was out bearish on Tuesday:

“We increased the bearish bias in our portfolio last week on the basis of: (a) US data confirming that the Fed’s expectations are being met as the economy is growing around trend, (b) the prospects of more fiscal easing in Japan and (c) significant easing being already priced in Europe already (e.g. more than 20bps of cuts priced in).”

“Since we went to press on Friday, the case for an increase in the bearish bias has been strengthened by several factors. First, Abe’s election win will lead the market to focus on a potential fiscal stimulus in Japan. Second, positioning data indicate a shift to long positions (see graphs below). Third, (short-term) UK political uncertainty has receded with the forthcoming appointment of Theresa May as Prime Minister which has been supportive of European banks. Fourth, the risk of political contagion to Europe has receded as several polls suggest an increase of support for remaining in the EU in many countries.”

“Unlike previous episodes of US rates sell-off in H2-2013 and Q2-2015 when the market had accumulated large positions in EM bond funds and US HY funds creating some vulnerability for these asset classes, aggregate positions into EM and HY funds have been significantly reduced and the largest ‘bubble’ now corresponds to the cumulative net inflows (as % of AUM) into US government bond and US IG bond funds. In the meantime, cumulative net inflows into EU and US equity funds have turned negative since 2010. Based on this framework, there is room for some rotation of flows away from US Treasuries funds towards riskier assets.”

(Chart: Deutsche Bank)

Fair enough, Deutsche Bank.

But that certainly begs the following two questions: 1) what happens to that rotation when investors suddenly realized they rotated into a market trading at 17X?, and 2) what happens when those same investors realize that their rotation into stocks combined with lackluster guidance just drove the market to 20X while simultaneously causing rates to sell-off, thus collapsing the ERP and making Treasurys attractive once again?

Re-rotation, we suppose.

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