Gundlach sees more pain for bond bulls as long Treasuries sell off

Rout that began with a weak French debt auction has spread to the U.S. market

Jul 6, 2017 @ 3:53 pm

By Bloomberg News

Hedge funds that built up bullish long-end Treasury wagers to the highest outright level since 2008 are rushing for the exit as a government bond rout that started in Europe following a weak French debt auction spreads to the U.S. market.

Thirty-year yields surged as much as seven basis points Thursday to 2.9%, breaching both 50- and 200-day moving averages. Open interest in September long-bond futures has dropped by around $3.7 million since June 28 in dollar-value per basis point move, or DV01, terms, a sign bulls are starting to liquidate positions in the sector. Speculators in recent weeks were the most bullish on 30-year Treasury futures on a net basis this year, according to Commodity Futures Trading Commission data.

The recent selloff is a sign of more pain to come for Treasury bulls, according to DoubleLine Capital CEO Jeffrey Gundlach, whose firm oversees $109 billion and who said a year ago that yields had hit bottom.

With the Federal Reserve seemingly committed to raising interest rates a third time this year and speculation that the European Central Bank could announce a tapering of bond purchases by the end of the year, the fundamentals aren't encouraging. As yields are now approaching key technical marks that could trigger a fresh flush out of long-end bulls, the risk is building that Treasury yields go even higher.

Ten-year Treasury yields are on course to move "toward 3%" this year, Mr. Gundlach said in an emailed response to questions. There has "been no justification for the divergent policies in the U.S. versus Europe given economic fundamentals," he said — a point he has made previously.

A 10-year yield at 3% would put Treasuries in "definitive" bear market territory, Mr. Gundlach added. The yield traded as high as 2.39% Thursday, just ahead of a key retracement level at 2.42%, coinciding with the May high.

Thirty-year yields now sit just five basis points shy of their 100-day moving average, and a breach could prompt a renewed wave of selling. Curve positioning may also fuel liquidation in the long end as traders start to unwind overcrowded flattener trades. The spread between five- and 30-year yields is hovering close to 95 basis points, near the narrowest since 2007.

"People this year had been buying long-dated Treasuries and other sovereigns as the hedge to their equity portfolios and that's why this unwind is so ugly," said Peter Tchir, head of macro strategy at Brean Capital. "They are losing money on both the equity and debt side now, and are bailing out of their long-dated Treasuries."

Thursday's rout began in Europe after the results of a French debt auction showed a drop in excess demand for 30-year securities. Trading volumes in bund futures contracts jumped after the auction results were announced, sparking a surge in yields. The move gathered momentum as the yield rose above 0.51%, which Citigroup highlighted as "strong support."

Technically "the dam broke" in German 10-year bunds and "the cascade quickly flooded sell orders into 10-year futures, with the biggest 'emergency' overnight volume in months," Jim Vogel, a strategist at FTN Financial Capital Markets, said in a Thursday note to clients.

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