Explaining The Massacre In German Bunds

Traders all around the world have been puzzled by the unusually strong selloff in German bunds (the US equivalent of Treasuries) for the last week or so. Although the markets have been bombarded by volatility across all asset classes from stocks to currencies, the German market has been one of the hardest hit.

Which is surprising considering how German stocks (DAX 30 Index) and government bonds have been one of the best performers in extent times, all thanks to the ECB's PSPP. During the last 8 trading days, bund futures have seen a very vicious decline that seemed to have transpired from oblivion.

  Bund & BTP Contract Volume:  Volume across bund futures have surged to highs not seen since earlier in March when yields spiked in similar fashion. The sheer number of future contracts that have changed hands illustrates the panic in the trading rooms as long positions were liquidated in a very fast moving market.  Chart courtesy of Bloomberg

Bund & BTP Contract Volume: Volume across bund futures have surged to highs not seen since earlier in March when yields spiked in similar fashion. The sheer number of future contracts that have changed hands illustrates the panic in the trading rooms as long positions were liquidated in a very fast moving market.

Chart courtesy of Bloomberg

Update 2 (7/5 - Thursday):

It seems like we have got the most epic reversal we could ever have wished for today.

  Update 2 (7/5 - Thursday):  The high-low range of today's bar is the largest on record for bunds. At the lows of today, this week would have also been the bloodiest week on record for the bund market.  Just 16 days ago, 10-year bunds were yielding 0.04%, at today's highs, they were yielding close to 0.79%, nearly 1900% higher.  Such a rout has specific roots of technical and panic selling where gigantic sized positions (reported to be more than $2trn) continually suffer pain for consecutive days until their risk limits are breeched and the entire positions have to be sold at market.  All in all, an epic reversal for an epic day, courtesy of the Euronext breaking at just the right time.     Chart by Business Of Finance

Update 2 (7/5 - Thursday): The high-low range of today's bar is the largest on record for bunds. At the lows of today, this week would have also been the bloodiest week on record for the bund market.

Just 16 days ago, 10-year bunds were yielding 0.04%, at today's highs, they were yielding close to 0.79%, nearly 1900% higher.

Such a rout has specific roots of technical and panic selling where gigantic sized positions (reported to be more than $2trn) continually suffer pain for consecutive days until their risk limits are breeched and the entire positions have to be sold at market.

All in all, an epic reversal for an epic day, courtesy of the Euronext breaking at just the right time.   

Chart by Business Of Finance

Bunds continue to selloff at the open of European trading. Around 1 hour in, the DAX 30 was actually up for the day having erased most of its post-open losses.

However, something happened in the few minutes past 0440 EST that sparked a global sell off in risk assets. Stocks all around the globe from the Nikkei, the EuroStoxx 50, the FTSE 100, the S&P 500, risk assets along with bonds yields suddenly tumbled viciously.

The culprit is clear: Bunds

At the lows of Thursday, 10-year bunds trade at a 78bp, a staggering 17bp move from the open, and was one of the largest intraday moves on record.

Panic selling ensued, everything was dumped as both humans and HFTs were spooked. Dealers in trading desks spoke about zero liquidity and a quotes that were so off market most wouldn't believe it was happening.

Then the inevitable happened: Euronext broke

Specifically, at 1301 CET, Euronext (Europe's largest market exchange) issued a statement preempting traders of a connectivity blackout starting 1310 CET. Sure enough, the Euronext derivative market ceased to function at around the stated time, and only came back online at 1339 CET.

During this window of about 30 minutes, liquidity thinned to a thread and almost all of the selling ceased and sell orders canceled.

As a result, bund futures spiked tremendously when trading resumed on the exchange, pulling just about everything it dragged down back up to beyond unchanged for the day. The DAX 30 is now green for the day, and so are most equity indices.

That, ladies and gentlemen, is how you stop a rout dead in its tracks and orchestrate a market reversal in the most epic fashion.

Update 1 (5/5 - Tuesday):

We're in the second day of the new trading month and the selloff in bunds has continued unabated since trading began on Monday. A quick glance at US treasuries reveals that this week's selloff hasn't been isolated to Germany (so far). Treasuries were also hit quite hard along with bunds, with the 10-year yield on US paper testing the all important 200-day moving averag technical level.

  Update 1 (5/5 - Tuesday):  Strong selloff in the bund market continues through Tuesday. German stocks tanked hard after Monday's respite, testing their cycle lows on the DAX 30 Index.   Yields on 10-year bunds have broken a technical channel and have spiked to 0.50% from lows of 0.06% 15 days ago; an insane delta considering how historically stable bund yields have been.  Chart courtesy of Zero Hedge

Update 1 (5/5 - Tuesday): Strong selloff in the bund market continues through Tuesday. German stocks tanked hard after Monday's respite, testing their cycle lows on the DAX 30 Index.

Yields on 10-year bunds have broken a technical channel and have spiked to 0.50% from lows of 0.06% 15 days ago; an insane delta considering how historically stable bund yields have been.

Chart courtesy of Zero Hedge

Something More Significant? 

  German Bund Futures:  The current rout has seen yields on the 10-year bund spike by more than 30bp from just over 0% to 0.36% currently. Technically, key levels have still held and are intact. While it is difficult to tell if the entirety of the selloff has eclipsed, the continuation of the "ECB QE trade" should see bunds together with German equites perform positively going forward.   Chart by Business Of Finance

German Bund Futures: The current rout has seen yields on the 10-year bund spike by more than 30bp from just over 0% to 0.36% currently. Technically, key levels have still held and are intact. While it is difficult to tell if the entirety of the selloff has eclipsed, the continuation of the "ECB QE trade" should see bunds together with German equites perform positively going forward. 

Chart by Business Of Finance

Traders have been asking if the selloff in bunds signified something more significant than panic selling or a technical capitulation. Fears of an early ECB QE "taper" have been floating around

German bonds are the primary beneficiaries of the PSPP because the Bundesbank (Germany's National Bank) holds the highest capital key across the Euroarea national banks.

The selling seems to have climax yesterday after US 1Q15 GDP missed hugely, with yields on the 10-year bund rising from just over 0% to the current 0.36%, a staggering 30bp spike in yields. The amount of leveraged duration on the bund curve cannot be understated, and so has been the pain traders have endured over the last 2 weeks.

So is this selloff in bunds any different from previous ones? We don't think so. And we're not alone.

Although there has been concern over a lack of supply for bunds (i.e.  more demand than new issuance) creating a structural deficiency in the bund market, we believe that over the course of a few more months, the situation will normalize as the market adjusts to the ECB's purchases. 

Gross: "Short Of A Lifetime"

Recall that it was only last week when Janus Capital's Bill Gross, touted as the "bond king", called bunds the "short of a lifetime". Several other hedge fund managers jumped on board this bandwagon in the ensuing days. While Mr Gross may have been right in his call for the last 6 days, we don't think it will last. 

Technical Rather Than Fundamental

Bloomberg was kind enough to put out a summary of what various fixed income traders across Europe and London thought about the rout in bunds. Now armed with insight from the trading desk, we can summarize the selloff in 4 succinct words: "Technical leather than fundamental".

The so called ECB QE trade of shorting Euros and going long bunds was apparently very crowded. Everytime a trade gets too crowded, markets usually swing violently, running stops and setting off classic capitulation a where positions are squared all at once. "A rush for the exits" as they say.

Our opinion is firmly seated on the fundamental flows of capital into the primary beneficiary of the PSPP: German bonds, and inadvertently the equity markets. 

Fundamentally, nothing has changed very much apart from a slightly improving European economy. So for now, the rout in bunds offers traders an opportunity to get on board the train to even lower yields and tighter spreads

Such a rout has specific roots of technical and panic selling where gigantic sized positions (reported to be more than $2trn) continually suffer pain for consecutive days until their risk limits are breeched and the entire positions have to be sold at market.

Below, we present the opinions of various professional traders, via Bloomberg:

The rout in German debt and other European sovereign bonds was caused by market-technical factors such as investor positioning and supply glut rather than shift in views on economic outlook, analysts say, with profit-taking on successful QE trades, thin market liquidity and position-squaring before month-end are cited among main bearish catalysts.
A detailed breakdown by firm:
UBS (Mike Schumacher, Nishay Patel)
  • Spike in bund and UST yields over past two wks bolsters confidence in bearish call
  • Favor positioning for higher yields via France 5/10 steepeners and by paying EUR 5Y/5Y swaps
  • Weakness largely driven by technical factors, such as positioning, not fundamentals
Allianz Global Investors (Mauro Vittorangeli)
  • This isn’t start of bear market in bonds or developments that would persuade ECB to mull tapering QE early
  • Price action is more related to S/T supply and demand factors, as investors take profits and unwind ECB trades
RBS (Giles Gale)
  • Maintain L/T positive stance on German 10Y debt even after selloff
  • Weakness probably isn’t start of root-and-branch reappraisal of desired positioning and fundamentals; technical correction is the more likely explanation
  • Still see 10Y yields dropping to -0.13% on inflation, QE and now-cleaner positioning
RBC Capital Markets (Peter Schaffrik)
  • While no single driver for rout, position-squaring likely played a big role; “all that had gone up went down yesterday”
  • Good chance of more such moves in future; bond mkts have already taken a lot of bad news into account
  • Too early to favor outright shorts given Greek woes and tepid U.S. data
  • Prefer “semi-shorts,” such as B/E wideners, and U.S. 5/10 steepeners, U.K. 5/10 steepeners and short-end longs in spread products in euro area
Citigroup (Harvinder Sian)
  • While uncovered bobl auction isn’t necessarily a signal, progressively weak sales could point to changing investor behavior
  • Anecdotal evidence suggests some buying on dips and little by way of significant selling flows
HSBC (Bert Lourenco)
  • Yday’s rout in euro-area govt bonds was probably driven in part by “technical momentum players” amid supply glut
  • Stays constructive on EUR rates over longer term on inflation outlook, QE
  • Commerzbank (Christoph Rieger)
  • Cascade of small events created a large splash in a structurally ever-thinner mkt, similar to UST flash crash of Oct. 15
  • Test of zero line for 10Y yields should have been averted for now, with price bounces being used to reduce duration risk