By Min Zeng
The Trump trade is retreating in the bond market.
The yield on the benchmark 10-year Treasury note fell to a one-month low of 2.307% earlier Thursday. It was recently at 2.332%, compared with 2.368% Wednesday. Yields fall as bond prices rise.
Still, the note's yield has jumped from 1.867%, where it settled on election day. But after reaching a two-year high of 2.6% on Dec. 16, the yield has since been sliding.
The recovery shows investors are taking some chips off the table in the bond market after piling into the sell-Treasury trade. Investors have wagered that the prospect of large fiscal spending, lower taxes and lighter regulations proposed by U.S. President-elect Donald Trump will lead to stronger economic growth, accelerating inflation and a potentially faster pace of interest-rate increases by the Federal Reserve.
All these factors tend to shrink the value of outstanding bonds. Inflation chips away bonds' fixed returns over time and is a big threat to long-term government bonds.
The bond rout has stalled over the past few weeks, reflecting some concerns that policy details may fail to live up to market expectations. Mr. Trump, during his first press conference Wednesday since being elected, provided little fresh information on the fiscal outlook. Traders said this provided a fresh catalyst to fuel paring back short bets in the bond market. In doing so, investors come back to buy bonds, boosting bond prices.
When many pare their shorts at the same time, it tends to generate large moves in the bond market. A week ago, this factor led to the biggest one-day drop in the 10-year Treasury yield since June.
"I call it 'the honeymoon is over' trade," said Russ Certo, managing director of rates trading at Brean Capital LLC. The market is "disappointed about the lack of crystallized policy prescriptions" from Mr. Trump's press conference.
Two Treasury debt auctions this week drew strong demand. The overall demand for the $20 billion sale of 10-year notes reached the highest since June. Besides investors buying the auction to pare back short bets, a gauge of foreign demand increased as U.S. bonds continue to offer more attractive yields than their peers in Japan and Europe. A $12 billion sale of 30-year bonds is due at 1 p.m. Thursday, the last leg of this week's new Treasury note and bond offerings.
Some other markets also point to a pullback of the Trump trade.
The ICE dollar index fell to a one-month low Thursday after hitting the highest level since 2002 earlier this month. Gold has been rebounding after selling offafter the election. Government bond yields in some other developed markets such as Germany and the U.K. have also pulled back from their recent highs.
Lopsided positioning has been whipping global markets in recent years. Since the financial crisis, ultraloose monetary stimulus from major central banks have fueled large price gains in stocks, bonds and commodities, and caused investors to crowd into trades. Over the past few months, investors had piled into wagers on higher stocks, lower bond prices and a stronger dollar, betting on pro-growth fiscal policy in the U.S.
The risk for investors is that a selloff or rally in one market easily ripples into others. This is compounded by hedge funds which use superfast computers and automated algorithm strategies to place bets when a trend or momentum develops in markets.
There are some signs that wagers on higher yields, known as short bets, are getting stretched.
Hedge funds and money managers held a net $94.3 billion in Treasury futures contracts, betting on a rise in U.S. bond yields for the week that ended Jan. 3, according to data from TD Securities. It was the highest since 2008, when the bank started to track the weekly data. The amount has soared from $42.2 billion for the week that ended on election day.
The net wagers betting on a stronger dollar stood at $26.6 billion for the week that ended Jan. 3, near a one-year high, according to data from J.P. Morgan Chase & Co.
Some investors say any pullback in bond yields won't last for long as they see higher yields as part of the process for the bond market to normalize from record lows.
The 10-year Treasury yield was less than half of where it had traded in 2007. It has been climbing from its record low of 1.366% set in early July. A number of economic releases over the past few months have pointed to improvement in global manufacturing sectors,and upticks in inflation indicators in China, the eurozone and the U.K. In the U.S., a gauge of wage inflation last month hit the highest since 2009.
"The gist is that fundamental pressures still show risks for yields to rise because inflation expectations are rising to reflect better economic data and the potential for better data," said Jim Caron, global fixed-income portfolio manager at Morgan Stanley Investment Management.
Mr. Caron said he continues to underweight Treasury bonds in his portfolio, a stance reflecting his expectation of higher bond yields. "We are thinking of adding to that underweight," he said.
Jim Paulsen, chief investment strategist at Wells Capital Management, said bond yields and stock prices could rise significantly more than most appreciate.
"Throughout this [economic] recovery, bond yields have been kept artificially below free market levels" due to central banks' large bond-buying programs,Mr. Paulsen said.
Write to Min Zeng at email@example.com
(END) Dow Jones Newswires
January 12, 2017 10:39 ET (15:39 GMT)
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