The latest results from the weekly surveys on Twitter showed equity investors are still torn between a bullish outlook on the fundamentals vs less than convincing technicals. On the bond side, investors had a change in heart on the week as 10-Year yields failed to convincingly break through the 3% mark. Part of that failed move may be down to over-crowding on the short side, but as I outline below, investors may be under-appreciating the amount of quantitative tightening that has been done so far, and that which is in the pipeline, and of course the market impact of the great monetary policy experiment coming full circle.
The key takeaways from the stock and bond sentiment snapshot are:
- Equity investors remain torn; bullish on fundamentals, bearish on technicals.
- Bond investors had a change in heart on the week as the breakout through 3% seemed to fail.
- Traders remain heavily short treasuries, but as the charts show, the Fed has been steadily reducing its holdings.
- Quantitative Tightening may be still be underappreciated by the market in terms of scale and impact.
1. Fundamentals vs Technicals Sentiment: The latest weekly survey results showed fundamentals net-bullish sentiment off slightly, but still at pretty optimistic levels. Technicals sentiment on the other hand went further bearish on the week. As a reminder, the survey asks respondents to indicate whether they are bullish vs bearish for technical vs fundamental reasoning. So it remains a picture of investors basically saying the fundamentals (e.g. economy and earnings) still look good, but the technicals (i.e. price action) are less than convincing.
2. Equity vs Bond Fundamentals: Looking at the fundamentals sentiment picture for bonds vs equities, there remains a gap, with bond investors reassessing the extent of their bearishness on fundamentals steadily through this year against stubbornly steadfast optimism on the fundamentals by equity investors. Something is going to have to give on this chart - the gap will either close by bond investors getting more bearish on the fundamentals, or equity investors capitulating on their optimism. One of those is "reflation" the other is "deflation."
3. Bond Sentiment vs the US 10-Year Bond Yield: In terms of overall sentiment for bonds, the chart below shows the net bulls (overall bullish minus overall bearish sentiment), and there was a distinct change in heart this week - presumably survey respondents are taking the so-far failed breakout through 3% as a sign that bond yields may be capped short-term..
4. Quantitative Tightening vs Government Bond Yields: One reason to be skeptical of a further surge in bond yields is the stretched speculative futures positioning. While this is not necessarily a barrier to higher yields (indeed by the chart below traders have been on the right side of the move in bonds) with positioning looking fairly crowded to the short side there is a risk of a pullback. Having said that, when a market is undergoing a major trend change positioning and sentiment can become stretched and stay stretched.
5. Quantitative Tightening vs Government Bond Yields: And if you want a reason to expect higher bond yields, you need only look at the Fed. In April the Fed stepped up the cap for quantitative tightening to $18 billlion per month for treasuries and $12 billion per month for asset backed securities - in line with its pre-announced plan to steadily accelerate quantitative tightening. The next scheduled step up will be in July where the pace of QT will be lifted to $24 billion for treasuries and $16 billion for ABS, or a total of $40 billion per month (for context, QE3 saw monthly purchases of $85 billion).
While the improvement in the growth/inflation outlook has been a key driver for higher bond yields, looking at the chart below you can't help but think that quantitative tightening is at least a contributing factor, if not a major factor in the trend of rising bond yields. And unless we hit another recession, QT is only going to accelerate.
6. Quantitative Tightening vs the S&P 500: And if you think quantitative tightening is only going to cause issues for the bond market, then you may want to check out the chart below. Of course there are many other factors at play, but if you thought that quantitative easing was bullish on the way up, logic dictates that all else equal quantitative tightening will be bearish on the way down.
