Bonds Are Sliding and Analysts Are Struggling for an Explanation

(Bloomberg) -- The global selloff in long-dated bonds is dividing opinion among traders and analysts. Some explain it as profit taking, others point to the stronger-than-expected U.S. inflation data, and a few are flagging the possibility of a so-called reflation trade.

Stronger-than-forecast gains in U.S. consumer price indexes in June are being cited as an obvious answer, given the figures prompted rates traders to trim bets on how much easing is on the way from the Federal Reserve.

This explanation, though, doesn’t explain the out-performance on Thursday of two-year Treasuries. That tenor should have been more sensitive to the monetary policy outlook than longer-dated bonds. And it doesn’t explain why European bonds were sold even before the American CPI report.

Treasury 30-year bond yields jumped eight basis points on Thursday, the most since October, outpacing an increase of three basis points in two-year notes. Germany’s 30-year yields rose seven basis points on Thursday, while two-year yields were little changed.

Royal Bank of Canada pointed to a “slight reflation theme” amid expectations the euro area will benefit the most from global easing.

Mizuho Securities Co. was unequivocal in pinning Thursday’s action on reflation trades, in which investors buy riskier assets while selling bonds on expectations that monetary easing will accelerate growth and inflation.

Soft demand at a 30-year Treasury bond auction Thursday is consistent with this theory.

But the most straightforward explanation is profit taking following the best return in three years for for global bonds in the second quarter. Because futures have already priced in almost a 1% point rate reduction by the Fed before the end of next year, U.S. monetary policy alone may not extend the rally in Treasuries.

Asset managers have boosted their net long positions in Treasury 10-year note futures to 885,068 contracts from a year-to-date low of 676,213 contracts in April, according to data from the U.S. Commodity Futures Trading Commission.

Franklin Templeton Investments Australia has exited its bullish positioning in the U.S. and Australian debt markets, said Andrew Canobi, director for fixed income in Melbourne.

“The drawback of narratives is they lag behind market pricing,” Canobi said.

To contact the reporters on this story: Masaki Kondo in Tokyo at mkondo3@bloomberg.net;Ruth Carson in Singapore at rliew6@bloomberg.net

To contact the editors responsible for this story: Tan Hwee Ann at hatan@bloomberg.net, Brett Miller

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