The Bond Short Has Closed: Now What?

According to the CFTC data, the short position across the US Treasury curve has now closed.  The data from Tuesday (when TY closed 2/3 of a point below current levels) shows that duration-weighted speculative positioning across TU, FV, TY, US, and WN contracts inched into positive territory for the first time since August.  (The chart below expressed the positioning in terms of long-bond contract equivalents.)


What now?

On the face of it, Macro Man confesses to the temptation to start layering shorts after one of everyone's favourite trades has blown up.  However, digging a bit deeper offers substantial reasons to think twice.  First of all, the seasonality points to lower yields, and it's only getting stronger over the next few months.


Furthermore, it's worth noting that while the policy authorities remain upbeat, there would appear to be substantial room for disappointment.  The NY Fed, for example, expects good growth for the remainder of this year and stellar growth for next year.  On aggregate, they see the risks to this forecast as tilted to the upside; your author would humbly suggest that they're much more likely tilted in the other direction.



While it's true that short end futures are already pricing a substantial discount to the 1% Fed funds forecast of FRBNY and the infamous dots, it is also the case that the 2-10 curve is still very steep by the standards of history, as well as the levels prevailing for much of the "forward guidance era."


Furthermore, given that rampant ECB speculation has prompted an orgiastic rally in all German fixed income products, it is worth noting that the 10y US-Germany spread has edged out to nearly 120 bps,  which isn't quite the all time time high but is still at the 98th percentile of the last 20 years.

 As a reminder, 3 month cash rates are 10 bps higher in Europe than they are in the US, and German GDP growth printed greater than 3% annualized in Q1 while the equivalent US data now looks a dead cert to be negative.   Even factoring in some payback in the current quarter, German growth is likely to be something like double the rate of its American equivalent in the first half of the year...yet the Treasury/Bund spread has widened since December 31st!


Insofar as 2014 is proving to be the Year of Disappointment in the market Zodiac, the UST/Bund spread would appear to have a lot going for it.  If US growth disappoints, the spread should (eventually) narrow.   If the ECB action proves to be a 'sell the fact', the spread should narrow.  If everything that's worked eventually reverses, the spread should narrow.  Obviously if the ECB keeps the market on the hook, always expecting more, while US developments prove hawkish, the trade probably won't work.

But as value proposition in a market where there's plenty of room to add UST length (and/or decrease German rates length), the spread would appear to have a lot going for it.
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abee crombie
admin
May 19, 2014 at 1:12 PM ×

Interesting thoughts on the Bund/Notes spread. I thought most punters were playing it via the 5 year, which looks extended as well but still has another 40bps or so to run into 2005 wides.

I'm getting more worried about China, the RE market seems to have turned. There is a lot of complacency in the markets while normal toppish signals are showing up (Momo fizzle/Defensive Rotation, M&A heating up, rates).

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Leftback
admin
May 19, 2014 at 4:03 PM ×

LB still has half an eye on the BTP-bund spread, as the post-Draghi bazooka one-way trade in European peripheral sovereigns seems to have turned. If this continues, then risk aversion in Europe is yet another factor to support lower US yields.

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Leftback
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May 19, 2014 at 4:33 PM ×

A nice simple post that emphasizes the fact that US Treasuries are in some ways, a bargain!

Many Govies Yield Less Than Tsys

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