Merrill Lynch on 5s 30s: Overdone

April 22nd, 2014 9:02 pm | by John Jansen |

I apologize for the format as I could not get this to print any other way. Think of it as an E E Cummings poem (and maybe I should have written his name in lower case). As an aside I would often quote a line from E E Cummings when I was hawking bonds for a living. I believe he has a poem which begins “A salesman is an it that stinks excuse”. Ouch! Here is a link to the full version of the Cummings poem. It is rather far afield from the vagaries of the 5s 30s curve but some of his work is powerful, moving and quite idiosyncratic.

Via Merrill Lynch Research

Situation Room
22 April 2014
6
Rates Strategy
Curveball
By Priya Misra
A persistent bid for the long end
The recent decline in US interest
rates has been led by the long end, which has
flattened the 5s
30s yield curve to levels not seen since 2009. In our opinion, the
flattening in the early part of this year led by weakness in the belly of the curve
was justified. However, in the last few w
eeks, the curve has flattened as forward
rates have declined. The 5y5y rates are now at their lowest level since July 2013.
Last week was particularly perplexing
the 5s
30s curve flattened by 14bp while
S&P 500 increased by 3% and 10y TIPS breakevens ro
se by 7bp. This is a rare
occurrence. Since 2012, on weeks where the stock market rose by at least 1%,
30y rates rose nearly 90% of the time, and the 5s
30s curve steepened 93% of
the time.
What is driving this move? We analyze the usual suspects and argu
e that the
move seems overdone.
LDI (p
ension
) demand for duration
It has been well advertised that 2013 brought significant improvement in defined
benefit (DB) pension funded ratios. Funded ratios increased by the largest
amount in a single year in the last 14 years, which argues for some rebalancing
and duration needs.
EPFR fund flow data shows a small pick
up in inflows into
government and corporate long
duration funds. This may be symptomatic of
pension rebalancing via money managers, which makes its way into demand for
the long end.
However, funded ratios have given
up some of the improvement in 1Q. Given the
stock market sell
off and decline in long
end rates, ratios have declined by about
five percentage points for the top 100 corporate DB plans this year, according to
Milliman. It is possible that we are seeing th
e lagged impact of the improvement
in funded ratios from 2013 because of the need for management approval to
rebalance pension portfolios. If this is true, this flow should be limited and not

indefinite

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  1. 4 Responses to “Merrill Lynch on 5s 30s: Overdone”

  2. By CGC on Apr 22, 2014 | Reply

    How about the fact that the Japanese Pension fund (GPIF) needs to diversify, out of domestic debt (JPY 30yr yields are sub 1.70), and BoJ policy is going to continue to cheapen the Yen…Italy’s 30yr is 4.15, and Peripherals are as tight as they’ve been as the ECB will likely be pushed into some form of asset purchases or risk serious currencies issues v Japan…now, nothing goes in a straight line, and there can certainly be tactical trades…but what’s going on here, to me, seems structural..so, absent a much weaker US labor market, the market seems to be telling us that one CB is removing liquidity, while others are adding it…all this while equities percolate to all time highs in an environment of moderate, at best, growth….

  3. By John Jansen on Apr 22, 2014 | Reply

    Well put my friend. You seem a bit negative on equities. I continue to believe that as long as GDP is in the 2.5 zone you will get enough profit growth to justify current levels. Last year S and P gained about 30 percent. This year thus far it is flat. Possibly we are in range for a bit as earnings catch up with slightly stretched valuations.

  4. By AP on Apr 23, 2014 | Reply

    That’s not the CGC I know, is it?

  5. By John Jansen on Apr 23, 2014 | Reply

    someone else you know employing an alias

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