Morgan Stanley Identifies The Source Of Massive Treasury Selling
In recent weeks we have been pointing out the stark divergence between markets in various geographic time zones, most notably the variance in equity “moods” between the Europe and US, where it often appears that there are two regimes: one ending when Europe closes and another starting, with both usually mirror images.
But while we mostly focused on how geography impacts stock markets, a far more interesting observation was made this week by Morgan Stanley’s chief rates strategist Matthew Hornbach, who over the weekend identified the origin, if not quite the identity, of the persistent seller of Treasurys over the past few months, who has sparked such a violent rout across not just the US rates space but also stocks and other core assets.
As the following remarkable chart from Hornbach makes very clear, the cumulative downward price movement in Treasury futures has been concentrated in the Tokyo session. Furthermore, after a brief respite in the first week of March, selling in the Tokyo session accelerated dramatically ahead of the FOMC meeting and it continued afterward.
Of course, the initial burst of Treasury futures selling – which appears to have originated out of Japan every time – would then have a domino effect on the rest of the world, and as Morgan Stanley notes, “weak price action during the Tokyo session led to additional selling during the London session” although to a lesser extent. As the next chart shows, since the start of the year, 85% of the cumulative decline in TY futures prices occurred in the overnight session, i.e., Japan is almost single-handedly responsible for the dump surge in yields this year!
Why does this matter?
Because if Morgan Stanley is right, and if the seemingly daily Treasury selling indeed originates out of Tokyo, there is finally good news for bond bulls: Hornbach writes that “we have good reason to believe the selling from Japan won’t last… into April.” That’s because the fiscal year in Japan ends on March 31. “At that point, liquidation of non-yen bond holdings should stop, if not reverse at some point in the April-June quarter.“
But why did Japan sell non-yen bonds in the first place?
According to Morgan Stanley, Japanese commercial banks hold a large number of equity shares, and the Nikkei 225 equity index put in its best fiscal year performance in decades. In other words, for the commercial banks, the income from bond holdings wasn’t necessary to make the year a successful one. Consider it one massive pension rebalance ahead of the March 31 fiscal year end… only this one was among commercial banks.
In addition, Hornbach adds that it was no longer necessary to take the risk that bond yields would keep rising, thereby subjecting their bond portfolios to capital losses in the last quarter of their fiscal year. At the same time, with a new fiscal year comes new revenue targets. And unless the banks have confidence in the Nikkei 225 index continuing to rise, the much more attractive carry and expected rolldown in the Treasury market will seem very appealing, according to the Morgan Stanley strategist.
In addition, the ability to realize that expected rolldown has been greatly enhanced by the higher bar the Fed set for tapering asset purchases and hiking rates.
Summary: Japan’s persistent year-end selling led to an adverse domino effect around the globe, which eventually sparked a global bond – and stock – market turmoil. However, that’s now over, and Japanese banks are about to start buying massive amounts of US TSYs again once the fiscal year is over. And while it remains to be seen where stocks will trade in the coming week (see “Month-End Set For Epic Clash Between Forced Pension Selling And Quant Buying“), it now appears that Q2 is set to start with a bang, as between sliding yields and stimmy checks, the S&P is set to finally rise above the mythical 4,000 level.
Tue, 03/23/2021 – 14:40