There is a famous trade out there called “The Widowmaker”. Here is Joe W of Business Insider describing the trade:
“In finance, the “Widowmaker” trade basically means one thing: Shorting Japanese Government Bonds (JGB) and inevitably losing money.
Because of Japan’s gigantic national debt, and because the Japanese bond rally has gone on so long, investors have called the top in the Japanese bond market for years, only to get impaled”
This has been going on for over 20 years now, and yet people have been crushed by the trade over and over again.
People are starting to think the government bonds in the United States should be shorted – because the U.S. has run up too much debt, and is engaged in “unlimited” QE. I put “unlimited” in quotes because in this case “unlimited” means “about as much as we did the last few times”. But the overall structure of the thinking is nearly exactly the same as how people have been thinking about Japan for the last 20 years.
The widowmaker trade works with a few easy to spot steps:
- Lots of people convince themselves inflation is right around the corner
- They sell government bonds in huge quantities
- They lose a ton of money when they are wrong about inflation
“One interesting development in the U.S. Treasury and related interest rate markets is the soaring volume of transactions as all types of market participants position themselves for a life without the Federal Reserve as a guaranteed buyer.”
People starting to realise QE was actually becoming a deflationary force? m.europe.wsj.com/articles/a/SB1…
— Izabella Kaminska (@izakaminska) May 31, 2013
“I am starting to think that QEII does the same thing with Treasury debt. It pushes potential sales of Treasuries forward into the actual period of QEII.If you were looking to sell $50bn of Treasury bonds in August, wouldn’t you at least consider moving the sale forward a few months, and selling those bonds in May or June? Who wants to sell during one of the all time great bond selloffs?The U.S. Federal Reserve has stated they would buy truckloads of bonds during QE II. So you know you can go into the market and sell, sell, sell – without any real impact on market prices.And if you’re considering selling Treasuries in May, why not sell them today? QEII might be suspended…and who wants to sell during one of the all time great bond selloffs? Why not sell them before that happens?
I think that every asset allocator in the world who is even considering selling Treasuries this year will do it earlier rather than during one of the great all time bond sell offs.
It’s cash for clunkers argument applied to Treasuries. It turns out that the critics of Cash for clunkers were correct – car sales did slow after CfC ended. Basically, it pulled a bunch of car sales out of the future and into the time frame of the Cash for clunkers program.
The Fed’s QEII is a great opportunity for weakly committed holders of Treasuries to exit their positions. There is a known huge buyer of Treasuries in the market – why not sell to that known huge buyer?
I suspect this same thinking has something to do with the huge rally that happened at the end of QE I as well. If you recall, there was nearly universal bearishness for the post-QE I bond market, but the day it stopped, bonds went on a historic rally. All of the sellers had already sold when they knew the Fed would be there – so only natural buyers were left in the market.
“1) Large bond portfolios (think PIMCO, DoubleLine, etc). are getting out of the way in advance of Fed tapering. You can debate if they are early or not, but it is what it is.2) Watch the impact this has on credit driven purchases: House (especially) but also Autos and CapEx.”