People talk of the 2013 ‘taper tantrum’ as the modern-day equivalent of the enormous 1994 bond rout, where both occasions saw the Federal Reserve unexpectedly communicate a significant change in monetary policy. But the Treasury selloff we have seen since September 2017, at least at the front end of the curve, is on a par with 2013. US 5-year Treasury yields have soared from the September lows of 1.6% to as high as 2.6% in early February. Although the market volatility in February has been concentrated in equities, it is surely the recent US rate market implied tightening that is at least one of the root causes.
We have looked at whether Treasury selloffs of this magnitude have had any predictive power for total returns, and they have.
The chart below plots the 5-month rolling change in 5-year Treasury yields this Millennium (blue line). There have been around 10 other instances since 2000 when 5-year US Treasuries have sold off as aggressively as in the past five months, but only the selloff in 2002, which came in the middle of a big bull market, was of a greater magnitude. The red line shows the subsequent total return of the US Treasury market in the following five months.
Clearly the fit is far from perfect, but large sustained US Treasury selloffs precede Treasury market rallies almost without fail, and large falls in yield tend to precede periods of poorer returns. To an extent this is by definition, since lower 5-year yields mean lower future nominal total returns over the five years as a whole (i.e. simplistically a 60-basis point drop in yield translates into a 25bps lower return over a five-month period if nothing changes). But the extra yield only makes up a minority of the outperformance of US Treasuries after an aggressive selloff – even just focusing on yield changes rather than total return, we have found that 5-year US Treasury yields see a decline 83% of the time over the next five months when there has been a 75bps selloff over the past five months.
Now a cheeky second chart for our chart of the month (we couldn’t decide which was best, and both seem highly relevant and timely); speculative positioning in US Treasuries is once again around record all-time short levels, matching the short positions we saw at the end of 2016 when the market was obsessed by the idea that Trumponomics would result in soaring US inflation and growth. Below we have added together CFTC (Commodity Futures Trading Commission) speculative positioning for US 2-year Treasuries, 5-year Treasuries and 10-year Treasuries. When the market is hugely fearful, in the past it has paid to be greedy, and extreme short positioning at the end of 2016 preceded a decent rally in US Treasuries, as 10-year yields fell almost 60 basis points to the September lows. If history is any guide, we suspect the bond market is now similarly ripe for a rally.