Sharp shock

Strife and the Case for Stable Bond Yields

The vicious cycle of shorting U.S. government notes could be reversed after this rally.

Investors had a brutal reminder in the last 24 hours of the power of geopolitical events, and that could ripple through the most important market in the world.

The assassination of the Russian envoy to Turkey the same day that a truck attack shocked Germany triggered a rally in the 10-year U.S. Treasury that drove its yield down five basis points, the most since Dec. 2. 


10-year U.S. government bond yields have been climbing since early November

Source: Bloomberg

The move happened just as speculative short positions in Treasury futures were at the highest level since April 2010. On Dec. 13, noncommercial commitments of traders showed a net 268,395 contracts betting that the 10-year yield would rise, according to the weekly report of the Commodities and Futures Commission.

A Bulge in Bets

Speculative short positions in Treasury futures are at the highest level since April 2010

Source: Bloomberg

Large bearish positions make a market ripe for a short squeeze, which this time may have come in the form of the twin tragedies.

Granted, the U.S. Treasury market is so big that a sudden reversal of bets doesn't necessarily translate into large, lasting moves. It could be enough to change the sentiment about the direction of yields, though, and that is key. 

There are many reasons why short interest in Treasury yields has risen so much: Expectations of higher inflation, accelerating growth in the U.S., promises of fiscal stimulus under the incoming administration of Donald Trump; the list is long. One of them is quite technical, yet no less important. 

It relates to mortgages in the U.S., and therefore affects the broader economy. There currently are $14.2 trillion in housing loans outstanding in America -- only $500 billion short of the record reached in the second quarter of 2008.

Now Watch Homeowners

U.S. mortgage lending isn't far short of the 2008 record

Source: Federal Reserve

A good part of those loans are owned by financial institutions that assume they will be repaid within an average number of years. The 10-year Treasury is the benchmark for 30-year mortgages, so every time its yield drops, those institutions assume people will repay faster, because they can refinance at a lower rate. The opposite is also true.

So, when yields are rising, these institutions expect they will hold these loans for longer in an environment of higher returns, which affects the net present value of the debt. To hedge for those paper losses, they short 10-year Treasuries. 

Now, notice, the instrument they short is the one that benchmarks the loans they own. This can create a vicious circle that keeps pushing up the yield on 10-year bonds, and other maturities with it. Rates for new mortgages tend to rise, and that can hurt the economy.

Which is why the sudden reversal could be useful. Once investors who expected yields to continue rising start paring their bearish bets, the benchmark rate may stabilize. At least until the next Trump tweet promising to push U.S. inflation back to the level of the 1980s.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Christopher Langner in Singapore at

    To contact the editor responsible for this story:
    Paul Sillitoe at

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