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THE RETURN OF THE WIDOWMAKER?

Are JGBs a buy? Or is just a shake out?

Yesterday I wondered if the collapse of SVB was the top of the US hiking cycle. In summary, I thought unless I saw a trend change in GLD/TLT I would not get too worried.

I also like the price action of US treasuries. If 2 year yields fell, my expectation was that the long end would sell off as markets priced in more inflation. Which is what we saw in TLT. It opened much higher yesterday, before closing on it lows.

One reason I love long GLD/short TLT trades so much is that fund flow has been the opposite of this. We can get the shares outstanding in GLD and TLT to see how much money is on either side of this trade. People have broadly given up on GLD, while they have been pouring money into TLT.

In fact people are so bullish on 30 year treasuries, they are at almost a record discount to the 2 year treasury. Lets say a normal spread is 200bp (2%), and you bought 30 year treasury at 4%, even if the Fed cuts back to 1%, at best you can only make 25% on this trade. But lets say the Fed cuts to 4%, and inflation comes back, then you could see the 30 year go to 6%, and you end up losing 33% of your capital. And price action yesterday seemed to be confirming that much more balance view on treasuries.

However, to my surprise when I woke up this mornings, 30 year JGB yields have plummeted. I also won’t lie, this put the fear of god into me. JGBs have been a very good lead on treasuries, and for good reason. If Japanese yields fall, Japanese investors will start buying treasuries, forcing yields down. And every major deflationary event I know off begins with JGB yields falling.

Japanese banks, with are a very leveraged inflation trade have been smoked with the move lower in JGB yields. In perhaps the oldest chart in macro trading is the relative performance of Japanese banks and the movement in JGB yields.

Not many years ago, a move like this in JGBs would have me selling all equities, buying Yen, and buying treasuries, and shorting every inflation trade I could find. That is short gold, and long TLT - the total opposite of the above. What you might call a brown trouser moment. Should we ignore the JGB market? One reason why it has had an outsized move is that the BOJ has been buying more bonds recently.

IT has been doing this to maintain JGBs at level within its yield curve control program. That meant there was very little volatility in JGBs, meaning that leverage short positions could have build up. When these are closed explosive price action is possible, which is what we have seen.

Finally, the 30 year JGB yield was trading much closer to a normal spread against the 2 year JGB yield. That is the curve is much steeper than in the US. That is there was much more room for the 30 year to rally (yields fall).

So where does this leave us all? Well my view is that politics is now pro-labour and pro-inflation. While I can understand that people look at the failure of SVB as a rerun of the GFC, for me its part and parcel with policy to reduce income inequality by making work pay more, and speculation pay less. As a reminder, this is not a lefty political view, this is an observation on where the votes are. And politicians go where the votes are. I think inflation is here to stay, and more than likely this is a chance to put more inflation trades on.

Discussion about this video

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A Walking Gentleman's avatar

Yeah I think this is bang on the money. The piece that investors are missing at the moment is that old style QE (bail outs) and inflation can co-exist it just leads to currency debasement so Long Store of Value / Short TLT is a good expression of this new structure for now.

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Billy Bunter's avatar

There will with regret be some new Widows todays. The market appears to be unable to cope with QT and rising rates . We live in a highly financialized system and imagine will hear within a few days of the end of QT.

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Russell Clark's avatar

Given the collapse in oil and yields, I am pretty sure we will be hearing about government stimulus soon

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Thomas's avatar

To re-iterate your view of how the Fed comes into this picture, your argument is that if they start easing, they are likely to only ease down to FFR at 4%. This makes sense, but in light of recent events, do you think that with their new BTFP facility enabling them to better accommodate financial system issues, this increases the odds of them tightening more than what the market has re-priced in the OIS curve recently, giving us a deflationary recession, and forcing them to cut rates even further than that? I'm starting to think that a GLD IEF barbell makes sense over the next 12-18 months even assuming your call is correct. It seems like a lower risk play than a GLD/TLT pair trade. Does this make sense?

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Anup Singh's avatar

That was a super fun talk. I was trying to find the next trade this weekend staring at the JGB 2Yr and 10Yr and Gold and Crude oil. What I did not know is why the TOPIX and Yield behave the way they do. Thank you

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A Walking Gentleman's avatar

Yeah I think this is bang on the money. The piece that investors are missing at the moment is that old style QE (bail outs) and inflation can co-exist it just leads to currency debasement so Long Store of Value / Short TLT is a good expression of this new structure for now.

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Clement's avatar

I agree that the JGB curve is distorted because the BoJ has practically nationalised the bond market.

To be confident that we have really gone pro-labour and escaped deflation, ideally I'd like to see BoJ abandon yield curve control.

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Russell Clark's avatar

Agreed - that why it freaked me out a bit... I can see why JGBs have rallied, so might not need to worry too much. To be fair gilts have rallied far more than I would have thought too

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Clement's avatar

My gut feel tells me that USDCNH is the one to watch out for to confirm/refute your thesis

If it appreciates (Yuan depreciates) past 7.40 then you can say the CCP has decided to devalue - and the reflation thesis would be toast.

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Russell Clark's avatar

Yes. Just as the US devaluing the dollar in 1972 was the begininning of.the end of the inflationary era

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