No Bond Vigilantes: Just Record Short Futures Speculators

A reader asked me about "Bond Vigilantes". There aren't any, but there is a record number of speculators.

A reader asked me about 'Bond Vigilantes' after reading this article: 'Bond Vigilantes' are Saddled Up and Ready to Push Rates Higher.

  • There's reason to be concerned about bond vigilantes, who are no longer under "lock and key" and are free to push yields higher, Ed Yardeni told CNBC.
  • Yardeni coined the term "bond vigilantes" in the 1980s to refer to investors who sell their holdings in an effort to enforce fiscal discipline.
  • People are looking more at the domestic situation and saying, 'You know what, maybe we need a higher bond yield,'" Yardeni says.

This is complete silliness. There are no "Bond Vigilantes".

Fundamentally, there is no way to dump holdings to enforce "fiscal discipline" because someone has to hold every bond issued until it comes to term.

However, there is a record speculative building up against bonds in the futures market.

Hedge Funds Push Record Bets Shorting Treasuries

Hedge funds and other large speculators are more convinced than ever that the 2018 bond-market rout will resume in the days ahead.

The group, known for trading on momentum, boosted short bets in 10-year Treasury futures to a record 939,351 contracts, according to Commodity Futures Trading Commission data through Feb. 6. That means the violent market moves on Feb. 5, when the Dow Jones Industrial Average suffered an unprecedented drop and 10-year yields fell almost 14 basis points, weren’t enough to dissuade wagers that rates are headed higher. The next gut-check comes Wednesday, with the latest read on consumer prices.

Speculators’ positioning matters because it can push momentum to extremes, and can serve as a contrarian indicator since these traders are among the quickest to switch directions when prices turn against them. By contrast, longer-term holders like asset managers are seen as more likely to stay the course. Their net long in 10-year futures is the highest since October 2015.

30-Year Long Bond Positioning

The chart from COTbase is not to scale. Moreover, the bars represent the price of the bond, not the yield on a 30-year bond.

However, we can see, that when it comes to shorting 30-year treasuries, small speculators display terrible timing. They are positioned for another beating if the yield on 30-year treasures declines.

10-Year Note Positioning

Small speculators have been short the 10-year note since the beginning of last year. They are now almost as net short as the big speculators. Bloomberg cites a record short position. Bloomberg may be counting options.

The top half of the chart is from CotPriceCharts. Those small and large spec bars are to scale. I overlaid a chart of yield for the same time frame.

There is also free COT data at FreeCOTData but it does not separate out small from big specs.

COT Data Releases

Generally, the data in the COT Reports is from Tuesday and released Friday. The CFTC receives the data from the reporting firms on Wednesday morning and then corrects and verifies the data for release by Friday afternoon.These reports have a futures only report and a combined futures and options report.

The charting services take the data and produce charts, some of them free.

A key point to remember is you are always looking at stale data. In volatile weeks positions can change rapidly. The data released on February 9, for February 2, is very suspect. We get a new report on February 16.

Another VIX-Like Opportunity

Speculators have been adding leverage, getting shorter and shorter as yields increase. This is a recipe for disaster at turns.

Let's not confuse increasing speculation with 'bond vigilante' myth.

The widespread beliefs that the Trump tax cuts will fuel investment and inflation will rise because of wages are both half-baked at best. For now, as long as traders are on the right side of things, it doesn't really matter why.

One reason yields have been rising is the opposite of what people think. For discussion, please see Trapped Funds Myth: Foreign Cash Repatriation Boom in Reverse.

Mike "Mish" Shedlock

Canada will be seeing inflation as NDP governments push to a $15 minimum wage but I doubt the same in the US as automation seems to be on the horizon (trucking & fast food) to counter it. I’m waiting for the inflection point where housing collapses in Canada and all hell breaks loose. Hopefully it’s before Trudeau gets a 2nd term.

Are bond vigilantes from a time before QE and Chinamerica?

Poor analysis Mish: "Fundamentally, there is no way to dump holdings to enforce "fiscal discipline" because someone has to hold every bond issued until it comes to term." Yes, demand and supply reach equilibrium, but at a lower price and thus higher yield. Econ 101.

True. Also overlooks deficits meaning that there is continuous new supply. Even if you are prepared to take the credit, nothing forces you to buy new bonds at any particular yield - could just hold cash deposits. Test (maybe) is to try to see how willing genuinely overseas holders are to buy new issuance.

Absurd - One cannot dump securities - It's mathematically impossible in aggregate. Supply and demand have to equal. So what? Where did I ever suggest that was not the case? Please point it out.

Surely nothing forces an country in surplus with the US to buy US bonds with the surplus? Could just decide to sit with the cash balances until yields are attractive - and the reduction in aggregate demand for new supply (forced by running deficits) makes yields rise?

Mish- You implied that the bond market cannot enforce fiscal discipline except through leverage and futures. Not true. If investors think yields need to be higher, then they will go higher. Why? Because demand will fall, the price will decline, yields will rise, and the market will then clear (at a higher yield). This happened well before futures even existed.

I've always view "Bond Vigilantes" as a tongue-in-cheek expression. People are dumping their bonds b/c they fear rates are going up and they don' want to get crushed. They're not doing it out of civic responsibility.

Call me whatever you want. I sold some bond funds because the position was losing money.

The current generation of "bond vigilantes" may not be sellers of bonds, but rather it could be that the traditional bond holders may simply no longer be buyers, or worse, demand a higher yield. With the projected level of debt issuance coming in the next decade, that could be just as damaging. Pension funds will likely be liquidating holdings in the coming years to pay retirees. China and Japan may be tapped out. What, beyond higher yields, will attract future bond buyers? And who will they be?

It is possible the term was "tongue-in-cheek" otherwise there is no mathematical basis. That is indeed what I thought until I read that article. The article is similar to the same as "cash on the sidelines" nonsense if you think a bit. It implies that someone can sell without their being buyers. Given the sheer number of fools who perpetuate such nonsense, it was worth a discussion. Even some of my readers don't get it. This is however, a sentiment issue, and a supply issue. The Fed is tapering as deficits are rising!

Mish is right that the Fed is tapering QE as deficits and.interest rates are rising. I admit this trade looks like a slam dunk for bond shorts even as a very crowded trade. As Yogi used to say I hate to make predictions especially about the future, imo if the interest rate on the 10 year note goes shooting up much higher beyond 3%,, the boys who are leveraged short in our equity markets are going to be kicking ass so gonna b lots of fun to watch!

The prospect of Bond Vigilantes returning is definitely real. It's very simple - if bond investors fear higher rates they will simply demand a higher premium 'at issue', or they'll start to jettison what they have or they'll hedge their rates exposure. All the above will push rates higher. There is no law that says investors have to buy at the issuers price. When a corporate issuer come to market the lead under-writer builds a book around where investors are prepared to buy the deal -- which may be at much higher rates. The tsunami of liquidity in recent years has meant that issuers have been in charge but a combination of monetary tightening by the Fed and the coming deluge of issuance by the US Treasury is going to give control back to investors (the vigilantes). There is a very real prospect that the 35yr bond bull market is about to come to an abrupt end -- if that is indeed the case then rates are going much higher, with zero prospect of issuers being anything other than price-takers.

The seller sets the yield, if they set it wrong, and in this large a market the mere act of setting yields MAKES it right, if the buyers don't like it they can a) stay home b) move down the curve c) lowball the bid d) hedge the risk . The sellers first concern is getting the product monetized so government doesnt shut itself down. The idea of raising rates keeps foreign money flowing, and helps the dollar, which for offshore buyers is a concern. The Fed is captive of forces right now which have no bearing on the domestic economy, other than government spending. The swamp just ate Trump.