Bonds r screwed

The_Ni · May 9, 2022, 7:49pm

@KneifKneif and other bond gurus, bonds seem to have done what we were expecting for a while - yields went down, and appreciably:

The bond volatility MOVE index is also down compared to a week ago:

When I check the IV on 5/20 TLT options, both calls and puts have lost value, which supports this idea of bond volatility reducing appreciably:

On one hand, this means that the market is behaving as it should - out of equity, and into bonds.

Except, we have not been doing this until now. Both bonds and equity were going down. Are here indications that the market has now accepted that we are not at the bottom, and there is more to fall, so they are parking money into bonds now? Aka… a precursor to capitulation?

Don’t mean to fear monger, just trying to make sense of this change in sentiment.

KneifKneif · May 17, 2022, 11:58am

I think the reason stocks fell in tandem around the time fed announced it was pulling its stimulus is that the fed didn’t just buy treasury bonds they bought cooperate bonds as well. Raising of cooperate yields raises red flags for people who watch cooperate bonds.

I’ve seen it mentioned a lot I haven’t dug deep into it to see if that’s the case but regardless i believe bonds and stocks saw the same pain because bonds got spooked by balance sheet reductions whilst stocks got spooked by interest rates threading growth.

Looking at historical charts it seems once federal reserve changes policy bonds and stocks move in tandem but once things become more settled down they go back to inverse relationships, I think this is the case since December federal reserve policy drove both down now that things are more priced accordingly they now go back to that completion for investor dollar relationship.

KneifKneif · May 17, 2022, 12:09pm

Bonds bouncing off 2018 lows it was around this price level fed came in supportive of markets before Covid came in and screwed everything up.

Real yields have been positive for quite a few days now as well.

Inflation has quote on quote peaked, I’m not convinced of that just yet.

Don’t have much for expectations going forward still a lot to be seen from inflation data and how the fed reduces its balance sheet.

Still expect some funds to rotate from stocks into bonds as investor bearish sentiment is still pretty high.

notmisa · May 17, 2022, 12:21pm

Thanks for the info. I need to learn more about how corporate bonds work.

I too noticed an influx into bonds recently, but from a technical stand point, it looks like somewhat of a standard retracement (on TLT). I wonder if these are catalyzed by algos more than actual market news.

You can see retracements since the start of the year and they tend to go back between the 9EMA and the 21EMA before continuing the trend. Had I noticed this earlier, I would’ve been a bit more patient with my TBF re-entry, but it seems the overarching trend continues. This gave me a chance to average down and I’m actually +100% on a 5/20 TBF call now.

Also, I want to know how quickly bond ETFs price in upcoming changes so that we can play the reverse of this downtrend once inflation and interest rates come back down.

notmisa · January 11, 2023, 1:49am

It’s been a while since we’ve talked about bonds. There seems to finally be some certainty regarding the future of rate hikes (now that we’re seeing inflation finally come down). This has translated into higher highs and lower lows in the bond market. I mentioned it briefly to @TheHouse in TF how the value of bonds appear to be strongly sensitive to interest rates rather than their historic inverse correlation to stocks. You can also see me initial theory on why the value of bonds were going to continue to fall down above.

With that being said, we’re now in a place where 50bps and pausing rates are finally starting to look like a real possibility (contingent on CPI). This will translate into TLT moving higher if my theory is correct.

I’ve heard some mention that we won’t be in a low interest rates environment for a long time, so I wouldn’t allocate a large amount to this position in expectations of reaching ATHs but it’s definitely worth looking into for diversification reasons.

Lastly, if stocks continue to fall while interest rate hikes slow, we could see big money move into bonds as a recession becomes inevitable.

The_Ni · January 11, 2023, 2:17am

Thanks for resurrecting this thread!

It’s been a tough year for 60/40 that seemed to have stood the test of time over … centuries?

We’ll probably need equities to find a new equilibrium, as the implied yield of stocks (inverse of P/E) needs to balance out with bonds.

It also doesn’t help that bonds can’t make up their minds about whether there will be a recession, if the Fed will pivot, and if the economy will continue to be strong. Here are all the pivots the long end did in just the last 3 months.

Perhaps summer will be a time to think seriously about 60/40 again.

Brutus · January 11, 2023, 2:58pm

Is 60 stocks and 40 bonds?

Labubs · January 11, 2023, 11:13pm

I got curious reading Ni’s post, found this article from October… you’re right, it is a 60% stocks/40% bonds portfolio:

This paragraph was interesting to me, kind of re-iterated jjcox’s post in the Stagflation thread saying how we’re in once in a lifetime/uncharted waters territory

Rice listed several reasons why the traditional 60/40 mix that had worked in past few decades seemed to under-perform: due to high equity valuations; monetary policies that have never previously been used; increased risks in bond funds; and low prices in the commodities markets. Another factor has been the explosion of digital technology that has substantially impacted the growth and operation of industries and economies.

Yngwar · June 5, 2023, 1:09pm

Just now looking into bonds and whatnot so my knowledge is quite rudimentary. Stumbled upon a conversation from other traders and thought to share.
From what I gathered it seems the US Treasuries yield curve has been inverted for a few months now in favor of short-term bonds with higher interest rates. And so the convo begins:

Trader 1: "So think about a bond, what is it? A bond is an agreement that is made that Person A will give money to Person B after the Bonds reach maturity, Person B will buy back the bond and pay the interest that is on the Bond. So, let’s say I’m person A and I issue a $1,000 bond with a coupon/interest rate of 2%. You as person B say, okay, and buy the bond. As the market moves the bond price moves up and down but so does me issuing new Bonds to other people so let’s say Person C wants to buy a bond from me, now price is down on my bond because Interest rates went up from 2% to 2.5%. So, his Bond is $900/2.5%. Same maturity date of 2 years. So, your Bond matures, and the bond issued to you has dropped in price and interest rates have gone up more. You purchase another bond from me again because you know now interest has gone from 2.5% to 3%. So, you are still collecting interest even though the price of the bond has gone down. This is how it should work I believe.

But the Bond market has been so weird lately that even though Papa Powell keeps raising rates the bonds dip (sometimes dip hard) but get bought right back up. Why is this: (here comes the tinfoil hat) because people don’t care about the Price of the Bond, they want to collect the interest. The market isn’t going to crater where a Treasury bill that matures 30years from now will not pay. They are taking it on the chin early to play the long game."

Trader 2: " So effectively the price of the bond doesn’t matter because these players are really just betting that the US won’t become insolvent."

Trader 1: "That is my theory, yes. The big boys collecting on interest and continue to buy because they get a better interest rate. "

Trader 2: " I mean, it makes sense. Especially if you’re a big pension fund or similar that needs to put capital to work and won’t risk dipping into equities. Might as well take advantage of historically high rates."

Trader 3: " Don’t forget the bonds/gold have a negative correlation to real yields. The bond market and the market was pricing in a rate cut. Breakeven which are inflation expectations for bonds haven’t been breaking lower which shows inflation isn’t breaking, but the narrative is. The bond market is now starting to price in another 25 bps rate hike in June. So, remember you also need to pay attention to the nominal rate but more importantly the real rate Us10y (nominal 10 y rate) - t10yi2(10-year inflation expectations) real rate. It is telling us inflation is going to be stickier than expected. Meaning CL is at a very attractive risk to reward set up. DXY is about to have a bullish trend.

Bond people: have you observed the same in the bond market in respect to the price of bonds trading with such volatility?

notmisa · June 23, 2023, 5:50pm

have you observed the same in the bond market in respect to the price of bonds trading with such volatility?

Yes. This is reflected through the MOVE index - which is the bond version of the VIX. In March, it was at 08 levels. You can also tell by how tall the candles on TLT were around then.

Regarding the Discussion You Pasted

This is part of a larger picture, but it’s pretty accurate in the way they describe the value dynamics of bonds. This cycle we learned that bond values are more sensitive to interest rates (and why) rather then them just being a small stock hedge.

Position Update

I have around $4,000 in TLT @ 103.91 and plan on adding another $4k thru the end of the year. I mentioned why I’m averaging into bonds during this cycle here in case you missed it.

Yngwar · July 15, 2023, 4:23pm

After further research I decided to join you on this bond trade idea. Makes sense to me. I did an initial buy of 14 shares around $101. Will add as the year progresses.

The_Ni · September 7, 2023, 4:29am

Good read from Bloomberg. Makes the case of the 10Y hitting 5.25% - about 1% higher than now. Excert below.

How High Can Long-Term Interest Rates Go?

Bet on a steepening yield curve

Who knows how long this will play out. But say the economy hits a rough patch. What then? Either the Fed has room to cut interest rates due to inflation’s decline or they keep rates firm because inflation remains sticky. And even then, you get the same steepening effect.

If the Fed cuts, its bull steepening because your high-return shorter-term investments will rally in price since they will be worth more in that lower-rate environment. But you’ll get no relief on the long end since a full percentage point of rate cuts are already being priced in.

If the Fed stands pat because inflation is too high, you might get some relief on your long-term investments. But how much can you expect since rate cuts are already being priced in for next year? If those cuts don’t come — and they won’t unless the economy really tanks or inflation falls a lot – the curve will steepen.

Finally, as long as consumption and investment remain robust, the no-recession crowd will be on-the-money. And that simply means there’s no sane reason lenders shouldn’t demand more interest from borrowers when lending money for longer periods of time. In bond-market parlance, that means a steeper yield curve. Or to be more precise, it means a bear steepening because the longer rates will be going up while the shorter rates will hold firm or go up, steepening the yield curve. That’s bearish, as your current fixed-income and bond investments will be worth less in that environment.

Overall, you should expect longer-term rates to rise relative to short-term rates, since even after the most-recent backup, the yield curve remains inverted. In fact, in a no-recession scenario, you should even expect longer-term interest rates to increase outright.

How high can they go? Well, at the beginning of the year I said 5.25%, simply because that was my expected ending for the Fed’s rate-hike campaign. The upper band is now higher than that, at 5.5%. My expectation was that even if we did see a shallow recession, the Fed would be loath to cut given how high inflation is. Eventually bond markets would start demanding higher rates for taking the duration risk of loaning money for longer periods. That thinking still makes sense. The longer this cycle goes though, the higher the rates can be.

With a Fed funds rate maybe hitting 5.75% by year-end — if policymakers opt for one more hike – 5%, 5.25% and even 5.5% are not out of the question for the 10-year Treasury.

If you are a saver or a lender, higher yields will be good especially if you can put your money to work on those higher yields. The problem with regional banks is they have so much of their money tied up in lower-yielding assets they can’t unload because of the hit to capital. But those that have money to deploy will be heartened. The borrowers who must pay higher rates and simply can’t afford it are less than 10% of households. So they and the lower-rated corporate companies will have to bear the brunt of the Fed’s medicine for the economy to slow.