Bonds Prone To Squeezing Higher After CPI

Authored by Simon White, Bloomberg macro strategist,

Treasuries are liable to being squeezed higher after today’s US inflation data as CTA funds cover their short position.

Bonds have begun to rally off their lows.

10-year yields are over 30 bps off their recent highs, while the Bloomberg Treasury Index is 1.4% off its recent low.

The set-up favors the rally continuing as commodity trading advisors start to cover their bond shorts.

CTAs typically deploy trend-following trading strategies, i.e. they tend to go with moves in assets, either up or down. Anecdotally, CTAs are historically very short global bonds, including US Treasuries. Bonds have been selling off around the world, with the Bloomberg Global Aggregate index seeing a peak-to-trough fall of almost 8% this year.

We can infer CTAs are short by looking at a multiple regression of the SG CTA Index (a composite of 20 CTAs) to the S&P and USTs, and charting the coefficient for the latter. When this is negative, as it is now, it likely means CTAs in the aggregate are short Treasuries.

Headline consumer inflation is anticipated to land at 3.6%. Obviously a much higher print would likely trigger another sell off. But CPI fixing swaps – “skin in the game” estimates from traders – expect headline to come in 3.55%, which rounds to 3.6% (based on Bloomberg-inferred data).

Further, there is little disagreement between economists, whose estimates in the Bloomberg survey are tightly bunched around the median, with 42 out of the 48 estimates expecting a number between 3.5% and 3.7%. This accords with leading indicators, which see the trend lower in headline and core inflation continuing through the end of the year.

Therefore, it feels the risks are tilted to bonds rallying, which could trigger self-reinforcing short covering from CTAs.