Epic Mexican Standoff Emerges In Treasurys

| About: ProShares UltraShort (TBT)
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Summary

It's high noon in the Treasury market as asset managers and hedge funds take opposite sides of the trade.

Who blinks first may well decide the fate of the reflation narrative.

Place your bets.

You know that feeling you get when two opposing sides with irreconcilable differences approach a pivotal moment, which one side will definitively lose?

Well, you should be getting that feeling about now if you've followed the evolution of the reflation/Trump trade.

I've spent all kinds of time documenting the reversal of Q4's consensus trades, and I've also been pretty adamant about pointing to the glaring discrepancy between that reversal and positioning.

Specifically, yields moved lower to start the year, but the massive Treasury (NYSEARCA:TLT) short (and the UST short, which is one part of what I've called the "reflation trinity") has only grown. In fact, it's now a four sigma event.

For their part, hedge funds are massively bearish. The following shows the gap between the 2-and-20 crowd's net long/short position and their historical net position expressed in standard deviations:

(Chart: SocGen)

By that measure, hedge funds' negative bias on Treasurys is a six sigma event!

Okay, so here's where this gets interesting. Have a look at the positioning of the 5-year futures:

(Charts: Deutsche Bank)

That is one hell of a discrepancy between pension funds, mutual funds, endowments, and insurance companies on one side, and hedge funds and CTAs on the other (right pane).

RBC's take: "somebody is going to get hurt badly."

On Wednesday, the bears won. Treasuries sold off sharply after CPI data, which showed ex-food and energy prices rising more than expected. "December CPI ex-food and energy rose 0.2%, in line with median estimates, though the unrounded increase was 0.23%, up from 0.15% in November," Bloomberg notes. The Y/Y increase (2.1%) was the largest since the summer of 2014.

But the real move came later when Janet Yellen delivered a speech in San Francisco. Her prepared remarks were released in the afternoon at 3 EST. "I and most of my colleagues were expecting last month to increase the benchmark lending rate a few times a year," the Fed Chair said, adding that "it is fair to say the economy is near maximum employment and inflation is moving toward our goal."

You can imagine how the market interpreted that:

Here's Bloomberg's summary:

Yields rose from the lowest closing levels this year, with about a third of the ~11bps increase in 5-year yields coming after Yellen's comments were released at 3pm ET. Yields across the curve were higher by 6-11bp as of 3:45 p.m. in New York

So the question here is: who will ultimately get burned? Real money or specs?

Perhaps consider taking a break from Trump's Twitter feed to check the CFTC data for clues as to who blinks first because it may well have implications for the fate of the reflation trade.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.