Sept 2. Quantitative Tightening and Risk Parity
-Ten year yield fell just 2.8 bps to 217.2 as oil and stocks tumbled. Curve was slightly steeper as 5’s led the move to lower yields, -3.8 bps to 150.2.
–Bonds have been trading poorly, without much of a ‘flight to quality’ bid as stocks have shown increasing vulnerability. A BBG piece this morning cites Quantitative Tightening (coined by DB) noting that “…central banks are either paring their reserves to offset an exit of capital or manage currencies, have less money flowing into their economies to salt away or no longer need to sit on as much. Whichever it is, the shrinking of reserves means much less money flowing into the financial system given authorities tended to recycle their cash piles into local currency or liquid assets such as bonds.” Global trade flows have shriveled, as evident by S Korea’s 15% decline in exports yesterday and by the ISM New Export Orders sub-category, which is at its lowest level since 2009.
–The other explanation for bond weakness is ‘risk parity’ funds, covered in the FT. As I understand it, these funds blend a stock portfolio with a levered bond fund, with the thinking that if stocks fall, the bond side over compensates. But in more volatile markets, apparently both asset classes need to be sold in order to maintain ratios. In any event, there are now two very public explanations for why bonds are weak. And when the easy explanations pop-up, then it’s almost certain that the weakness is over, and stronger hands are there to accumulate the weakness. EM currencies are weak. That’s been going on for a while…Brazil real at new low this morning 3.6987…but at some point the reserve selling eases. If a true financial crisis is again lurking, bond yields will fall. And the Fed will not tighten in two weeks, regardless of NFP.
–Today’s data includes Factory Orders expected +0.9 and ADP expected 210k
