Well, bad news for that crowded spec short in the 10Y: Goldman just slashed their year-end targets for G10 yields across the board.
Last Friday, when the latest CFTC data hit, Jeff Gundlach was pretty adamant about the possibility that a short squeeze might be imminent.
“Massive increase this week in short positions against 10 &30 yr UST mkts. Highest for both in history, by far”, Jeff tweeted, before warning that the lopsidedness “could cause quite a squeeze.”
As a reminder, the net non-commercial short in the 10Y increased to a record 698,194 contracts in the week through last Tuesday.
If you’ve followed Goldman’s forecasts for 10Y U.S. yields, you likely already knew what the rationale was here. Back in May, the bank suggested that Treasury shorts needn’t be concerned with how much company they had. A quick look at the chart above is all you need to remind yourself that while the position has gotten considerably more crowded, it had became a lopsided trade again by March.
“A common concern among investors is that positioning has become too crowded,” Goldman wrote in a note dated May 14, adding that “the market, the argument goes, cannot build up duration shorts indefinitely.”
Part of the bank’s counterargument revolved around the idea that extreme positioning can persist for quite a while. They gave some examples, like this one:
After net shorts reached a historical peak in March 2010, it took the market around 8 weeks to unwind them by 5 percentage points and another 10 weeks to cut further from the elevated 10%. The pattern is not limited to one episode, with similarly extreme positioning remaining extreme for months.
Goldman has been persistent in their argument that the term premium is too low and that’s what I meant above when I said that if you’ve followed Goldman’s U.S. yields forecasts, you likely already knew what the rationale was for their decision to slash their 2018 target. Here’s the bank, explaining on Wednesday:
First, we note that there has been no change to our view of Fed policy tightening—we still expect another six hikes, one every quarter, until we end with the federal funds target range at 3.25-3.5% by YE2019. We have, however, revised estimates of term premium increases down to 30-40bp. As a result of our analysis, we have also revised our estimate for the cyclical peak for 10y yields lower by 20bp, to 3.4%.
There you go. It’s down to a downward revision in their projection for the term premium. This is always a tedious discussion and in a recent note on the curve (mentioned here), Goldman gets into the specifics, but suffice to say the term premium discussion has vexed many a keen market observer.
As far as the rest of G10, they’re pricing a smaller spillover (i.e., a smaller bearish shock) from the U.S. and the downward revision to 10Y bund and JGB yields reflects “a later start to normalization” in Europe and Japan, following Draghi’s introduction of date-dependent rates guidance and the BoJ’s adoption of forward guidance on rates late last month, respectively. Here’s Goldman:
We now forecast that US 10y yields will be around 3.10% (vs. 3.25% previously) by year-end 2018. The changes we have made to European and Japanese forecasts are more substantial—with 10y German, UK, and Japanese rates ending the year at 0.5%, 1.45% and 0.12% respectively.
So Goldman’s forecast for 10Y yields in the U.S. is now 3.10 by year-end, down from 3.25 previously.
If Jerome Powell ends up bowing to Trump and leaning dovish catalyzing Jeff Gundlach’s short squeeze, that 3.10 target may end up looking laughably high four months from now. Oh, and then there’s the possibility that Trump’s legal woes worsen and prompt a flight to safety.
On the other hand, the Fed minutes didn’t seem to suggest that policymakers are predisposed to taking a pause, and it seems unlikely that Powell is going to say anything in Jackson Hole that comes across as any semblance of dovish.
For more on that (i.e., for more on why a short squeeze might not in fact be in the cards) Bloomberg’s Brian Chappatta has great counterargument which you should take a few minutes to read here: “Gundlach Proves a Short Squeeze Excites Everyone“.
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