Investors are starting to question the epic bond rally that's driven global yields to new lows and fueled the U.S. Treasury market's best performance since the era of quantitative easing.
The warning signs go beyond this week's failed German 30-year bond auction, which showed that demand may be faltering for negative yields across Europe, even amid growing evidence of ebbing economic growth.
In the U.S., the momentum buyers who latched on to falling yields are seeing signs rates could be bottoming out, with volatility rising and market depth deteriorating. Cliff Asness, co-founder of quantitative investing giant AQR Capital Management, summed up valuation concerns in a blog post this month titled "Bonds are Frickin' Expensive." While Treasuries aren't "an automatic huge short," the levels are at least worth discussing with yields at such historical extremes, he wrote.
"It's sort of been the momentum traders' dream trade," said Kathryn Kaminski, chief research strategist and portfolio manager at AlphaSimplex Group. "Our conviction for bonds is still very strong, but there has been increased volatility — so in risky terms, risk trade-off has gotten worse. And with more risk, you become a little bit more skeptical."
Amid U.S.-China trade tension and worries about the global economy, yields plunged last week. Rates on 10-year Treasuries breached 1.5% for the first time since 2016, and 30-year yields fell to record lows below 2%. The market's bellwether U.S. recession indicator — the 2- to 10-year yield gap — inverted for the first time since 2007, sending stocks tumbling.
For traders riding the bond rally, it's been a stellar year. So good, in fact, that it's raising a warning flag for strategists at Societe Generale.
A SocGen index tracking the trend-following strategy in government-debt futures has climbed to a record, with algorithms positioned long across the curve.
"A strong performance by trend-following is usually followed by a reversal," the strategists wrote in a note.
Even for bond bulls, the market swings seen in the past few weeks are a reason to question the merit of staying long. Volatility on 3-month options for U.S. 10-year interest-rate swaps rose this month to the highest since January 2017.