One group of fixed-income traders have capitalized on the rip-roaring rally in government bonds that has driven their yields below zero.
So-called momentum traders that bet and ride on the continuation of price trends have thrived in part because they don’t care as much about how the U.S. economy fares because of the U.S. trade war with China or what the Federal Reserve will do in the coming months.
Such investors have profited from the one-way rally for government debt this year, and have been more than willing to jump into bullish trades using bond futures even as others remained skeptical that yields could go lower or even turn negative this year.
Société Générale’s index for trend-following strategies focused on the bond market have gained around 34% year-to-date.
“Certain fundamentals don’t make sense in a world of negative yields,” said Kathryn Kaminski, a portfolio manager for AlphaSimplex, a managed futures fund which employs trend-following strategies.
The swathe of negative yielding bonds have nearly doubled this year to $16 trillion, mostly across Europe and Japan, according to Bloomberg data.
Kaminski said the success in trend-following strategies contrasts with the broader view in Wall Street that the U.S. and global economy has not deteriorated to merit the magnitude of the rally in government bonds. Expectations among Wall Street banks that rates had no room to fall further have been repeatedly challenged this year, forcing them to revise their forecasts time and time again.
The 10-year yield for the U.S. Treasury note TMUBMUSD10Y, -5.87% and the German government bund TMBMKDE-10Y, -4.80% have given up more than 90 basis points since the start of the year.
That has delivered a fillip to bullish positions in long-term debt. The future for a 30-year Treasury bond expiring in September USU19, +0.93% is sitting on a 14% gain year-to-date.
See: Here are four reasons why investors might snap up negative-yielding bonds
Kaminski said momentum indicators continue to point to a further rally in Treasurys, even as investors say long-term rates are unlikely to decline further from here as long as the prospect of a recession appears distant.
The tension between economic fundamentals and the market’s response came into full relief in August, when the 10-year Treasury yield fell around 50 basis points.
Analysts at JP Morgan said less than half of the bond-market’s rally this month could be explained by the deterioration in the economic growth outlook and expectations for further monetary easing by central banks. The rest was explained by strategies based on momentum indicators.
Check out: Here’s why the bond market isn’t as worried about a recession as you think
Sandrine Ungari, head of cross-asset quantitative research at Société Générale, wrote many of the trend-following market participants including commodity trading advisors and managed futures funds started to establish long positions across government bond markets at the beginning of the year as they bet on yields falling and bond prices rising.
Even now, such traders are bullish on subzero-yielding Japanese, German and French government paper, according to SocGen data.
To be sure, Ungari cautions further gains in momentum strategies are likely to be capped.
“A strong performance by trend-following is usually followed by a reversal,” she said.