The most hotly debated issue on trading desks right now is the mini-rally in bonds and bond funds we have been seeing in the past few days. What's behind it?
Likely, not too much. At least not yet.
Here's what traders have focused on:
1). A modest uptick in prices in bonds and bond ETFs in the last several days, but particularly in Treasury ETFs. Other bond ETFs like iShares Investment Grade and iShares Core Aggregate, the largest bond ETF, have also seen modest price hikes. Volumes have not been particularly strong until Wednesday, when many bond ETFs saw heavy inflows.
2). Bond ETFs were also well-represented in January fund inflows. Not surprisingly, plain-vanilla stock ETFs like the Vanguard S&P 500 Index saw inflows, but surprisingly bond funds like Vanguard Intermediate Term Corporate, Vanguard Short-Term Bond and iShares Investment Grade Corporate all saw notable inflows.
What's going on? First, regarding the recent rally, the rise in prices has been pretty modest, and the volumes (other than Wednesday's) have been small. There has been no countervailing move in stocks. What fits with these facts? Seems to me that some modest short covering is the answer. We do know that traders heavily shorted bonds after the election and maintained those shorts. Modest covering could easily account for the price rise, and the fact that stocks have not reacted.
Second, it's perfectly reasonable to assume that some investors surveyed the landscape after the first of the year and came to a simple conclusion: Interest rates have already risen, but they are unlikely to go through the roof.
"My hunch is that there is no panic that 10-year yields are going to 4 percent anytime soon," said Dave Nadig, CEO of ETF.com. "There's also the added yield play. Investors can see that they are getting 70 basis points more yield than they were getting in October."