Thread by @beth_stanton

Let's talk about what happened in TIPS (inflation-protected #Treasuries) at the end of the US trading day yesterday. 🧵

What we *know* happened is that benchmark yields -- already higher on the day -- shot up quite a bit more between 3pm and 4pm, with the 5Y reaching a YTD high.

What we can *surmise* happened is that it had something to do with month-end index rebalancing.

On the last business day of the month bond indexes get rebalanced to bring in bonds that got issued & remove ones that no longer fit the index criteria (typically because they have less than a year remaining until maturity). It happens instantaneously, usually at 4pm.

It's a big deal for index funds (and closet index funds) because if to perform like the index, they need to rebalance at the same time as the index.

In the Treasury market it's often a bigger-than-normal deal at the end of Feb, May, Aug and Nov, when the most new notes and bonds get issued. The index can undergo a bigger-than-average change as a result.

That was the case for the end-of-Aug rebalancing, for TIPS as well as regular Treasuries, in part because there was a 30-year TIPS auction during the month.

But also, the potential for index rebalancing to make waves in the market is bigger in TIPS. First because its a smaller, less liquid market (about $1.8t, vs $18t of nominal Treasuries).

Second because the main TIPS ETF $TIP is a $30b giant. Fewer than 10 bond ETFs are bigger, and they're all corporate or multi-sector bond funds.

Whether an index rebalancing moves the market depends on how accurately the sell side estimated how much index funds were going to need to buy. Yesterday, it appears the sell side overestimated demand & was left with excess risk.

Sometimes a big month-end move gets "corrected" the next day. That's not happening. TIPS yields are rising further, outpacing nominal yields. That's indicative of a broader reassessment of demand for TIPS (which appeared strong in the 30-year auction on Aug. 18).

Even at a time of high inflation, outflows from TIPS funds suggest sentiment is souring. Reasons include:
*gasoline futures back to lowest levels since Jan
*CPI deceleration in July
*Fed's pledge to restore price stability at all costs
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