A bond sell-off could be 'Armageddon' for the market

The stock market keeps hitting record highs because of a potent cocktail of strong earnings and solid global economic growth. The corporate tax cut is a nice little chaser.

But some experts are increasingly concerned that the hangover will be a doozy.

They worry that U.S. bond yields will rise much more dramatically than Wall Street expects. That could force the Federal Reserve to raise interest rates more aggressively to fight inflation -- and stop the market rally, slow the economy and make it more expensive for people and businesses to get loans.

A sell-off in bonds could be "the Armageddon event for this year," Naeem Aslam, chief market analyst for Think Markets UK, wrote in a report Tuesday.

Analysts worry that China will slow its purchases of American bonds. That would push yields higher because rates go up as bond prices go down.

The Bank of Japan has also been buying less in Japanese bonds -- a sign that many countries are looking to end financial crisis-era stimulus measures. That, too, should push yields on Treasury bonds and other global bonds higher.

Here Come The Sellers: In Coming Days Pension Funds Set To Sell Most Stocks In A Year

Traders are perplexed by today's market action: not only did the S&P stage a dramatic intraday reversal from session highs, and all three indices are now red on the day, but so far the BTFD ETF flows are missing. What gives?

We may have an explanation courtesy of Credit Suisse, which writes in a trading note that U.S. pension funds that rebalance monthly - which is most of them - will have to sell more than $12 billion of stocks in the coming days to return to prior asset allocation levels given recent rally in the stock market - the S&P is up 6% YTD while bonds are down just shy of 1%.

As a result, CS calculates that funds are expected to sell a sizable $12BN in equities and buy roughly $24BN in fixed income. The amount of selling, CS writes "would be the biggest in at least a year for a month that does not coincide with quarter-end."

The details from Credit Suisse:

• Equities have had a strong start to the year with the S&P 500 up 6.5% MTD.  As a result, our model currently estimates selling in U.S. equities to total just over $12bn from funds that rebalance on a monthly basis – a relatively large amount relative to recent history for a month that does not coincide with quarter-end.  
• In addition, U.S. pension funds are also expected to be net sellers of international equities due to their similarly strong performance (MSCI EAFE up 6.8% and MSCI EM up 8.7%).  We estimate over $9bn of selling in Developed Market equities and $3bn in selling of Emerging Market equities.  
• Given the relative underperformance versus equities, we expect the significant rotation of assets into fixed income to continue.  Our model estimates slightly under $24bn of buying in fixed income securities in total.

CS does caution that projections may shift materially based on the relative performance of asset classes and that "In practice, pension fund rebalancing may not specifically fall on a specific day (e.g. month-end) and the actual timing of trades can vary based on several different factors including market sentiment, implementation costs, and regularly scheduled cash flows."

Bloomberg confirms as much writing that today is the trigger day for month-end rebalancing, and warns that today's action may be a signal to expect pension rebalancing over the next week.

What about over the longer-term?

This weekend, JPMorgan's Flows and Liquidity note revealed that "the average long-term sovereign yield level at which pension funds would start de-risking was 2.8% and the yield at which they would expect to be fully hedged was 3.7%. The 30y UST yield at 2.9% currently has already crossed the 2.8% level mentioned in this survey."

Furthermore, JPM calculations suggest that this year's 5% rise in equity prices alone could create up to $125bn of pending rebalancing flow by US defined pension plans.

We look for G4 pension funds and insurance companies overall to buy a lot more bonds than the $460bn bought last year, and for their bond buying to return to at least the 2016 pace of $640bn. In fact, we see upside risks to this projection assuming equity markets remain strong.

To JPM the news is bullish for the long-end of bond curves: "This pension fund rebalancing flow should support the long end of DM bond curves causing further flattening this year."

As to what forced pension selling of stocks will mean for equities, we may find out in the next few days...

US Equities Tumble On Ross' China "Direct Threat" Comments

Everything was looking so awesome this morning.. .until Commerce Secretary Wilbur Ross told a group in Davis that China's 2025 Technology Plan was a "direct threat" to the US, sparking another round of protectionist-fear-driven selling in stocks...

Trannies were already under pressure from United's drop, but Ross' comments pushed The S&P red briefly...

The move in stocks has also been assigned to the fact that 10Y Yields are back at 2.66%, triggering fears that TINA is over and the cost of funding buybacks is soaring.

Interestingly, no reaction in bonds or the dollar (which both continued their trends lower in price).