Thread by @MacroAlf

Why are yields rallying despite a 5% inflation print?
The incentive scheme for risk-takers in the financial industry (think traders and hedge fund PMs) is very important to grasp some of this move.
It's expensive to be short bonds over the summer.
A short thread on this.
1/5

The chart in the tweet above shows the carry and roll you get from being long 5y and 10y Italian and US bonds for the next 3 months. It's not huge but it's positive. It means you have to pay to be short these bonds in a low volatility scenario. Let's see how it works.
2/5

To be short these bonds you borrow them in repo and sell them in the hope to buy later at higher yields. You repo in a 10y Italian bond at -0.55% per year and sell the 10y bond yield at 0.75% per year (both against you). In 3m, you lost (0.55 + 0.75) / 4 = 0.325%. And more.
3/5

The bond became a 9.75y bond and the yield curve is upward sloping, so a shorter bond has less yield (the roll-down in simple terms).
All in all, if you are short you need 10y Italian bonds to rise in yield 7 bps just to break-even.
To break-even.
4/5

Traders and HF PMs are judged on their performance every month. Being short US or Italian bonds while nothing happens as Central Banks gobble issuance and dampen volatility is expensive.
They were forced to cover their shorts after realizing summer gonna be dull.
5/5