Time To Short Bonds?

Last Friday, CASAM (whose ETF range is about to be renamed Amundi) listed six new inverse government bond ETFs, based on the EuroMTS indices. The ETFs offer exposure to the inverse daily performance of the EuroMTS Eurozone government broad bond index as a whole, plus to individual maturity bands within the index (1-3, 3-5, 5-7, 7-10 and 10-15 years).

Incidentally, the country weightings vary quite a bit across the maturity bands: in the 10-15 year index, for example, you end up with a substantially higher exposure to Italy (37%) than in the broad index (where Italy’s weighting is 25%), largely as a result of Germany having no suitable bonds in the target range.

This launch substantially expands investors’ options when placing short government bond positions via ETFs. Until now, only the Frankfurt- and Milan-listed db x-trackers short iBoxx Euro Sovereigns Eurozone TR ETF has been available to meet investor demand in this category, and it has attracted a reasonable amount of assets (€565 million at the latest count).

By comparison, the long version of the db x-trackers ETF has €765 million invested, suggesting that European investors are still, on balance, bullish on the prospects for their region’s government bonds.

In the US, however, things look quite different. The preferred ETF of many investors for shorting long US Treasury bonds, the ProShares Ultrashort Lehman 20+ year Treasury ETF (NYSE Arca:TBT), has US$4.7 billion invested, compared to only US$2.3 billion in the long equivalent (TLT – both funds offer 200% daily leverage). A year ago, the AUM figures were US$2.9 and US$1.9 billion, respectively, suggesting that investors have increased their bearish bet.

But are they betting the right way? I moderated the panel discussion on inflation and deflation at last week’s ETF conference, and my straw poll of hands at the outset of the session suggested that investors are already well-positioned for an inflationary outcome.

Specifically, I asked people whether they believed US consumer price inflation would average more or less than 1.5% over two years, and more or less than 2.6% over 20 years. I estimate that in both cases the show of hands was more than 90% in favour of higher inflation.

The inflation figures weren’t chosen at random – they were (last week) the break-even inflation rate implied by US TIPS and conventional Treasuries at those maturities. In other words, if investors were following what they said they believed, they would be buying more TIPS and selling more Treasuries.

And yet the annoying contrarian voice in my head tells me to watch out here – when views are so unanimous and when investors have positioned themselves predominantly one way, beware of the opposite outcome (deflation and lower bond yields), at least in the US.

The rise in sovereign default risk since last year throws another variable into the equation. Any further rise (which would equate to a rise in bonds’ real yields) could hit inflation-linked and conventional bonds at the same time.

Having been stopped out, painfully, from a short position in US Treasuries in late 2008 when 30-year yields collapsed to 2.5%, I’m reluctant to make a call here. But my gut feeling is that a bond rally would be the surprise outcome (and therefore perhaps more likely to happen).

All in all, though, the CASAM/Amundi ETFs fill a valuable niche, and I suspect more funds of this type will follow. With the Eurozone under pressure, how about some single country government bond long and short ETFs for Europe – or is that encouraging speculation?

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