Via Richard Gilhooly at TDSecurities :
The quarter came to and end with selling pressure in long-end Treasuries as the curve steepened 3bp on 5-30s, closing at 144bp. This represented a flattening of nearly 30bp in the quarter, from a June 30 close of 172bp, but was essentially flat on the last month, after closing at 145bp at the end of August. Negative carry for a month is running at around 4.5bp on 5-30s flatteners, while roll down of around 2bp in 5yr notes takes the break-even to around 6bp per month. At 18bp over the quarter, the flattener was still a winning trade, out-performing carry and roll-down by a decent 12bp in the quarter. However, the pace of flattening has waned and in the latest month the flattener has lost around 5bp versus carry and roll-down.
The big loser in the quarter were commodities, with crude oil dropping around 12% and a bit more for Brent crude, capped by a plunge today to end the quarter, with WTI down over $3 today alone. Gasoline futures fell to a new low for the year but TIPs stopped the bleed and 10yrs break-evens rebounded by 2bp. 30yr Breaks have fallen sharply and hit the lowest levels since 2011, at around 210bp.
Quarter-end flows can tend to create short term volatility that reflects position adjustment and not necessarily fundamentals, especially when there have been large move sin the quarter. The recent move in the Euro might have been influenced by a need to show less Euro exposure and could have exaggerated the latest decline, in addition to heightened expectations of ECB easing measures via ABS purchases and a possible hint at outright QE. The latest flattening in the yield curve in the past few weeks may have reflected similar pressures, while the unchanged monthly close could possibly indicate exhaustion of this move, especially with the Fed dots becoming more hawkish at mid-month.
The more interesting question will be investors view of the EM space after the significant FX weakening over the past month, mirrored by the worst performance from EM stocks since 2012. Weakness in Q1 was seen as a buying opportunity and rallied that sector strongly in Q2, as the Fed’s Taper proceeded and Treasury yields eased back. Q4 is normally not a time for investors to ramp up risk, unless there is a very compelling case on valuation and with the Fed being perceived as hawkish and commodities in free-fall we would expect pressure to intensify in coming months rather than move the other way.