Time is Running Out For the Bond Bears

With US Treasury 10 year yields at 2.49%, the likelihood that they will close the year in line with the bearish 3% consensus view is looking more and more remote. How much longer can the bears hold out?

There are only five months left in 2014, and the five month implied volatility for 10yr Treasuries is currently 0.29%. An implied volatility of 0.29% is one standard deviation, so for rates to rise 0.51% to reach 3% means they must experience a 1.76 standard deviation leap. Statistically, the chance of this happening is just 3.9% or one chance in 25.

‘Consensus’ forecasts measure Wall Street’s guru views and does not necessarily reflect the positions taken by real money investors. Real money, however, has been sympathetic to the consensus judging by the poor performance of Macro hedge funds this year. Ending 2014 with a 3% 10 year yield is simply not realistic, so expect downward revisions to start seeping through over the next few weeks. This will prompt some shorts to run for the doors…which will generate further downward momentum for bond yields.

While the consensus adheres to the positive growth-inflation correlation belief, it is hard to imagine Wall Street ever adopting a bullish bond view while yields are below 4%. The evidence in favour of this correlation is weak at best, so betting with consensus is a loss making enterprise. Wall Street’s loss is being harvested by the large natural bond investors, such as the Foreign Reserve managers in Asia and the Middle East, who are having a really good year!