Apr 22/15 – Bill don’t goocher my trade!

2015-04-22 6am EDT  |  #BIll Gross #bunds #Draghi #ECB #Germany

Yesterday former “Bond King” Bill Gross decided the time was right to go public about the potential outsized rewards of shorting German Bunds at a 0.10% yield.

Not only did Bill tweet about it, he then got on CNBC and hawked his trade to the masses.

Now I am fully aware that I am a hack who shouldn’t be wandering into half the squares I trade, but Bill’s peddling of the short bund trade brought out a whole new breed of macro tourists. Suddenly everyone wanted to get a short position on the sheets. Even Gandalf is rumoured to have put on a bund short on Gross’ recommendation.

My twitter feed was filled with traders asking for the symbol of the German Bund futures (pro tip: if you need to ask twitter the futures contract symbol, you probably shouldn’t be trading it). Or if it wasn’t questions about the symbol, my feed was filled with traders discussing the various German Bund ETFs they could short. The short bund trade suddenly became the must have trade. Which kind of pisses me off.

For the past week or so, I have been slowly establishing a significant German bund short position for my book. The Greece uncertainty has kept me from selling with both fists, but I have been piecing out my shorts in drabs and drabs into the rallies.

Yesterday’s development changed the dynamic. I am not fussed that Bill has encouraged everyone to short German Bunds – ultimately the Bund will go where it wants to go regardless of Bill’s recommendations. But now all of a sudden, we don’t know if yesterday’s crappy technical action was a “clean” reversal, or simply the result of hundreds of traders piggy backing on Bill’s call. Without all the noise about the “short of a lifetime” hype, I would be inclined to believe that yesterday’s reversal was the real thing. But now I can’t be sure…

Nevertheless I decided to accelerate my shorting into the weakening technical pattern. I am worried that I am trading alongside some pretty naive tourists. Yet I take solace in the fact that trading Bund futures is actually fairly difficult for most non-futures traders, so I am hopeful that yesterday’s reversal was legit, and that Gross simply pushed it a little farther along.

As for the longer term ramifications of Gross’ call; I have two messages for Bill. One – no shit sherlock. Of course Bunds will at some point be a terrific short. Yields have long ago passed into absurdsville. Secondly, and most importantly – you better not have goochered this trade. Talking about this in such a flashy public fashion, using language like “short of a lifetime” puts a big spotlight on your call. The Market Gods often find ways of making these sorts of grandiose proclamations look foolish. I know Bill wants to make a big splash and reclaim his “Bond King” moniker, but couldn’t he pick a trade I wasn’t involved in?

I have one final question; if Bill does manage to tick the low in Bund yields, will we forever know this as the Gross Bottom?

Why are bunds here anyway?

It is funny how quickly the market sentiment can shift. It was only a week ago no one could imagine bunds doing anything but continuing their seemingly predestined date with negative yields. Now everyone wants to start betting against bunds?

I have mistakenly believed that QE is ultimately inflationary, and thus not friendly for the long end of the curve. Unfortunately the ECB’s lack of credibility to create (and more importantly maintain) inflation is holding the traditional bond negative response to QE at bay.

The ECB’s QE liquidity is flowing into the system, and not translating into asset price changes as might have been hoped. For the past couple of months, investors have simply been hiding out in “riskless” German paper. From Citibank:

The most frequent client question is not based around economics or any market technicals but simply, who is buying Bunds at these levels'. The question usually comes with a look of incredulity. Other than the ECB buying, Figure 1 shows the net buying by investor classification, based on Citi's flows, which we think are representative of the market. The data shows that banks and asset managers have been the biggest buyers in the most weeks. Hedge funds had been short (perhaps erroneously positioned for a Fed QE style reaction) while pension and insurance industry flow has been more stable. Netting out all investors, German government bond flows are positive (more buying than selling), excluding central banks. Why? As we have remarked before, banks are buyers and likely to extend duration, while asset managers will be funding it costly to be short Bunds given the performance, even in global funds which tend to have more room to short core European bonds.

The real problem is that Draghi has failed to push back up long term inflation expectations. Yes, QE has stabilized the recent calamitous fall, but they are still way too low.

Here is everyone’s favourite long term inflation gauge – the EU 5 year forward 5 year inflation swap:

The market has been overwhelmed by a collective belief that the return of inflation is about as likely as Justin Bieber straightening out his act and stop being such a D-bag. This refusal to believe that the ECB can create inflation is the primary reason that their QE program has so far been ineffective and done nothing more except push down the remaining fixed income assets to stupidly low rates.

I don’t buy that the ECB’s QE will prove so impotent over the long run. And the market’s disbelief has created an environment where even more QE will be needed, thus ultimately making the reaction (and chance for an overshoot) all the greater.

I find it amusing that market participants believe that Central Banks are incapable of creating inflation. Some point in the next decade we will look back at this worry and laugh ourselves silly.

German bunds are a short of a lifetime, but so are most fixed income markets. The only difference is that bunds have been squeezed to an even more asinine level due to the market’s disbelief of Draghi’s commitment, along with a little bit of Greek contagion hedging.

As the market comes to understand that Draghi will not waver, and hopefully the Greek situation resolves itself one way or another, German bunds should experience a vicious bear market. Long term inflation expectations are still 1.5%+, so with the bund yielding 0.10% that is a negative real yield of well over 1%. When you take real yields down to these sorts of levels, eventually the economy responds. It wouldn’t surprise me at all if bunds were back to 1% by the end of the summer, but probably not until we shake off all these new found Bill-Gross-want-to-be tourists…

Thanks for reading,

Kevin Muir

the Macro Tourist