Rates Strategy Update: More to go

As an aside, my wife has a multiple fracture of her right wrist and therefore I have to take care of our 3 kids and the households for the next few weeks. I still hope to be able to write on a regular basis but it will be most likely a bit less frequent than usual.

Last week (see Rates Strategy: Here Comes the Weatherman dated Jan 12) I proposed a tactical bond-bullish stance for USTs and Bunds. In the meantime, 10y UST have dropped by 15bp and 10y Bunds by a bit less than 10bp. I still think that this movement has further to go amid all the reasons I provided last week:
a) positioning: the latest data available for Jan 12 suggest that aggregated net short positions in US 2y, 5y, 10y and 30y futures increased even further amid more pronounced net shorts in the 10y future. Overall net shorts are still slightly below the level prevailing at the end of May last year, i.e. just before yields reached their high for the year. However, net shorts in the 10y future have now surpassed their end-of May 2009 level and have reached levels last seen in April 2005.
b) technicals: I wrote last week that technicals were suggesting a temporary bounce might be imminent given that daily stochastics have turned upwards. This move higher in the stochastics can go on a bit further and we have not yet reached overbought levels. Furthermore, the 10y US T-Note contract has broken through its short-term downward trend which started at the end of November. Yields continue to trade within their established ranges (for 10y Bunds: roughly 3.09-3.45% and for 10y UST: 3.18-3.95%). In turn, the overall picture seems neutral (amid the range-trading behaviour of yields) with a bullish tilt (amid the rising stochastics)
c) fundamentals: According to the Citigroup economic surprise indicator for the US, economic data so far this year has rather surprised on the downside on average. The chart below shows the 10y UST yield together with this eco surprise indicator. Usually, the two time series move in a similar direction, albeit the timing and the extent of the moves are not perfect.

US economic surprises vs. 10y UST yields

Source: Bloomberg, Citigroup

d) the weather: I wrote last week about how colder-than-usual weather in the winter can be associated with a move lower in yields (with a delay) as it hinders economic activity. My proposed trading rule suggested that colder weather in a particular month is associated with lower yields in the subsequent month. December was colder than usual and in turn January has a higher-than-usual probability of a move lower in yields. Furthermore, the start of the year was colder-than-usual as well, be it in the US as well as in Europe.
e) supply: there was a tremendous amount of supply hitting the markets since the start of the year, be it in the sovereign sector as well as in the corporate segment. However, especially sovereign supply should be a bit less in the short-term. Furthermore, given the huge supply as well as the high level of coupon payments and redemptions, the end-of-the-month index extension will be a large one. This as well should provide some temporary market support.

So to sum up, the reasons for my positive tactical market outlook have not changed much over the past week and I stick to a bond-market positive assessment. Bund and UST yields are likely to fall further over the next weeks.