Rates Strategy Update: Still long

I continue to stick with my tactical long stance alongside the strategic bullish view for UST and Bunds (amid an outlook for a prolonged environment of low nominal growth).

Consensus remains heavily in favour of higher yields while positioning is reflecting this bias as net shorts in US bond futures have barely receded in the week up to Jan 19 (this data is always released with a one-week delay). As the chart below shows, the current level of shorts (I use the aggregate net positioning in the 2y, 5y 10y and 30y futures weighted according to their pvbp and is expressed in USD mln per bp), has over the past years always been followed by a (temporary) move lower in yields, irrespective of the medium-term trend.

Net short positioning remains at extreme levels (2y, 5y, 10y and 30y futures)

Source: CFTC, Research Ahead

Furthermore, as I laid down previously (see Rates Strategy: Here Comes the Weatherman dated Jan 12), the weather of the previous month (in the current case December) serves as a good indicator for the direction of bond yields during the next month (i.e. January). Colder (warmer) weather than usual during winter months is on average followed by a move lower (higher) in yields. The reason is most likely that colder-than-usual weather is a negative for the economy in the short-term (it negatively affects construction, retail sales and can also - especially if there are severe winter storms - affect industrial production. The only positive comes from utility output as well as the sale of winter gear). Not only has December been colder than is generally the case in the US as well as in large parts of Europe, January has also seen cold temperatures coupled with heavy snowfalls.
By now this has started to affect economic data releases and the Citigroup surprise indices for the Eurozone and the US have both moved into slight negative territory (i.e. there were more negative economic data surprises in the recent past than positive ones). January is the first month since April last year where both the USD and the EUR surprise index are both in negative territory at the same time.

Eurozone and US economic surprise indices are both in negative territory

Source: Citigroup via Bloomberg

Furthermore, equity markets have taken a hit last week and some multi-months trend lines have been broken to the downside. From a technical perspective what is most interesting is the violation of the upward trend in the CRB commodity index. As the chart below shows, the CRB index has been forming a strong upward trend since early March last year. This trend has been tested several times (in July, September and December) but always held. However, just last Friday, the trend was broken and the index finally closed below the trendline. A move lower in the commodity complex would help to ease inflation fears and should be met with a drop in break-even rates incorporated into inflation protected securities.

CRB index has finally broken its multi-months upward trend

Source: Bloomberg

Finally, the end of the month should see a rather substantial index extension, especially in the Eurozone, as there was the usual heavy supply, redemptions and coupon payments. This should as well temporarily underpin bond markets at the end of this week.
On the downside for bond markets is that near-term stochastic indicators are starting to look overbought. Furthermore, Greece is offering a syndicated deal this week. Should this sale go well, it could ease the risk of a near-term funding crisis and with that help spread products in general at the expense of Bunds.

Still, I think the positives outweigh these negatives at present and I therefore maintain my tactical bullish outlook for UST and Bunds.