① Compared to US stocks, the current level of demand for bonds among traders is close to the highest level in 20 years; ② This is certainly a true portrayal of the current market pattern, but if you are careless, it may become the next “painful transaction” in the market...
Financial Associated Press, December 7. As the downward trend in US inflation is basically in line with the Federal Reserve's estimates, traders are now preparing to reach a clear inflection point in the economy. This has contributed to the continued surge in US Treasury bonds over the past month.
In fact, as far as US stocks are concerned, the current level of demand for bonds by traders is close to the highest level in 20 years. This is certainly a true picture of the current market pattern, but if you are careless, it may become the next “painful transaction” in the market...
The position of long-term treasury bond options shows that the open positions benefiting from the rebound in long-term debt (bullish) are almost 2.5 times that of positions providing downside protection (bearish). This ratio is currently hovering near the peak set in September.
In contrast, short open positions that will benefit from falling stock markets are twice as many as long open positions. This shows that traders are ready for correction after a sharp rebound in stock valuations this year.
This one-sided options position means that the bullish level of bonds relative to stocks is approaching its highest value since 2005 — a reflection of the firm belief that an inflection point in the US economy is imminent.
Judging from recent macro news, it is not unreasonable for people to be extremely optimistic about bonds compared to stocks.
The overall inflation rate in the US was 6.5% at the end of last year, but now it has been reduced by half. The Fed's most popular inflation indicator, the core PCE price index, is currently 3.5%, which is lower than the Fed's earlier forecast of 3.7%.
The progress made by the Federal Reserve in its fight against inflation has led market participants to bet that the Fed will cut interest rates by a total of 125 basis points next year, far more than the Fed's own September bitmap forecast.
Although Federal Reserve Chairman Powell responded to claims of premature policy relaxation last week, if the anti-inflationary process in the US economy deepens further, the current high interest rates may indeed seem too restrictive. This certainly couldn't be better for bullish bets in the current bond market!
The risk still exists
Of course, similarly, risks remain for today's extreme bets in the market.
One of the main reasons against this bet is the current relative resilience of the US economy, as well as some reliable estimates — that neutral interest rates may have been reset higher after the pandemic.
It's no secret that the economy is performing far better than the expectations of Fed policymakers. The Federal Reserve predicted an economic growth rate of only 0.5% in 2023 at this time last year, but has now raised its estimate to 2.1%.
The Fed's own researchers also suggest that neutral interest rates — that is, they neither stimulate the economy nor suppress the economy's interest rate levels, may not only remain high for a longer period of time, but may also rise “permanently.” The prospect of higher neutral interest rates will also prevent the Fed from easing its policies too quickly.
In this context, considering that the rebound in US bonds over the past month has caused the 10-year US bond yield to plummet by about 75 basis points from the current round peak of 5.02%, this wave of market conditions seems to have gone too fast and too far.
Gennadiy Goldberg, an analyst at TD Securities, said in an interview this week that the rise in the US Treasury bond market is close to worrying levels, especially at the long end of the interest rate curve. He pointed out that currently there may have been some overbought situations in the US bond market. If the yield falls further, he may adopt some strategic adjustments.
Some industry insiders pointed out that in a context where the economy is still strong, these overwhelming biased positions in the market obviously do not rule out the risk that they may become the next “painful transaction” in the market.