Biggest Pain Trade Gives 37% Loss to Bond Bears Getting It Wrong

Updated on

What a dismal time for bond traders who were optimistic about growth.

Investors who poured more than $1 billion this year into a $3.8 billion leveraged exchange-traded fund that bets against long-dated U.S. Treasuries are suffering a 10.7 percent loss this month alone, Bloomberg data show. The fund is down 36.5 percent this year, a small window into the magnitude of pain in a market where many traders have been wagering debt prices would fall.

Treasuries have defied predictions across Wall Street for higher yields all year, and yesterday’s move is sending bond bears into a tailspin. Yields on 10-year Treasuries fell the most since March 2009, trading below 2 percent for the first time since June 2013 as a decline in retail sales prompted traders to reduce wagers the Federal Reserve will start raising interest rates next year.

The move is in part driven by traders covering their short bets, according to Jack Flaherty, an investment manager at GAM USA Inc. in New York.

“There’s been weakness, weakness, weakness and today it’s just ‘Get me out’,” Flaherty said yesterday.

Dealer Shorts

Primary dealers had the biggest short position on benchmark government notes at the beginning of the month since June 2013. They had a net $20.7 billion wager against notes maturing in the seven-to-eleven year range in the week ended Oct. 1, Fed data show.

It seems, though, that almost everything in the world is going against these bears right now. The global economy is slowing down, the Ebola epidemic in Western Africa is spreading, and conflicts in Iraq and Syria are escalating. All of that is translating into a surge in demand for the safety of Treasuries.

“We keep thinking we’re getting capitulation trades, but clearly there’s a lot more skeletons in the closet than we thought,” Ira Jersey, an interest-rate strategist at Credit Suisse Group AG in New York, wrote in an e-mail. “We’re also seeing more flight to quality buyers out of global asset classes that are considered ‘riskier.’”

Adding to the bout of general anxiety overwhelming the market was the data yesterday showing that U.S. retail sales dropped more than forecast in September on a broad pullback in spending.

Investor Flows

Over the past week, investors have plowed $1.5 billion into U.S. government bond ETFs, equal to more than 14 percent of all flows into the category this year. They’re flooding into debt that’s yielding the least in more than a year even though analysts surveyed by Bloomberg still expect 10-year yields to rise 0.6 percentage point to 2.7 percent in less than three months.

“The markets are clearly very jittery,” said Larry Milstein, managing director in New York of government-debt trading at R.W. Pressprich & Co. “It’s not just the global slowdown.”

While Wall Street economists may be sticking to their forecasts Treasuries will lose value, a lot of bond buyers aren’t listening right now. And the bears are suffering the consequences.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE