Things get a bit more interesting

Well, at least it got a bit interesting yesterday.  The fun started off in Europe, where the periphery widened sharply on stories of a potential capital gains tax on nonresident holders of Greek bonds (subsequently denied.)   The sell-off gained traction as punters searched for reasons and came up with polls showing extremist parties gaining traction in Greece and Italy.  10 year BTPS, for example, widened 15 bps, sending yields all the way back to where they were on....April 29.

Obviously, the break of the downtrend on the chart would suggest a deeper correction, perhaps to the 3.50% - 3.70% region.  Of course, that would suppose a single price continuum, when in reality the periphery is priced off of multiple equilibria- "normal" and "crisis."  Insofar as the recent rally partially reflects the ongoing transition from the latter to the former, it is reminiscent of the EMU convergence trades of the mid-late 90's.   Although the analogy is not perfect- markets now know the downside of the single currency zone, and should price risk more appropriately than in the early days of the euro- in a low return world it seems reasonable that peripheral carry will eventually win the day, at least in the absence of further policy error by the various national fiscal authorities, in which case the game changes.

As such, while a deeper correction may well eventuate (not least because length in the periphery is one of the few macro trades that has worked, is positioned, and hasn't been challenged), Macro Man suspects the dip will find enthusiastic demand.

In any event, equities were a bit on the back foot as punters dug out their 'BTP sell-off' playbooks when there was a line from the Slovak PM suggesting that Russia will turn off Europe's gas on June 1 if Ukraine doesn't pony up to Gazprom.   Obviously, starving Europe of a vital energy source, even in the summer, would be a significant development, and it is perhaps not a coincidence that risky assets turned lower straight afterwards.  There is some ways to go before that particular Rubicon is crossed, however, and it is clearly to be hoped that a resolution is found over the next couple of weeks.

Regardless, the negative vibe from Europe completely swamped the data releases from the US, which were generally balanced, possibly erring slightly towards the strong side.  (In fairness, some of the 'strong' data was waffley survey stuff like Empire and Philly.)  The lowest jobless claims since 2007 and a high core CPI reading were both shrugged off, with Treasuries rallying strongly across the curve.

We are now getting to a rather interesting juncture in US fixed income.  The Treasury curve keeps motoring, and frankly there isn't much to support 30 year yields til 3.00%.  Macro Man is more interested in the front end, however, which is more about getting monetary policy right than the panoply of factors that impact duration.  Although he has tended to focus on EDZ5 via futures flies and call ladders, it is EDZ6 that is currently grabbing his attention.

As the chart above illustrates, the contract is testing the little downtrend line off of the post-shudown highs last autumn, having rallied some 40 ticks since the aftermath of Yellen's first press conference.  What's notable about the current implied yield (1.98%) is that is lower than all but four of the dots for end-2016 from the last SEP.  Obviously, it is also lower than the mean and median forecast, both full sample and excluding the top three panelists.

So does this mean the contract is a slot?   It's tempting, particularly given the nice buildup in contract open interest during the rally of the next month or so.  However, there are a few things giving Macro Man pause:

* The risk to consensus growth forecasts seems clearly skewed to the downside, for reasons that have been discussed at length.   It would appear to be premature to scale into shorts until that risk is at least balanced.

* Price momentum is still strong and technical traders are likely adding and nowhere close to stopping.

* Eyeballing the option market, fading this move looks kind of expensive.   The midcurve 97.75/97.50 put spread, more than 25 ticks out of the money and with a lower strike below the low of the year, probably retails for 7.5 ticks.   That seems rich for what you get.

* Finally, given the trouble that the (in)famous dots have caused, Macro Man would not be at all surprised to see  Yellen's Fed chuck them off the Reichenbach Falls, never to be seen again, as part of yet another "enhanced" communications strategy.  If this occurs, Macro Man would expect the strip to rally because those dots have anchored expectations for year-end policy rates.  Remove the anchor and those rates can and will react more strongly to incoming data than they have in the recent past.  Given Macro Man's bias for the economy, it would be foolish to to go short if this is a legitimate possibility in the near future.

Nevertheless, Macro Man will likely start keeping a closer eye on the contract, looking for market dynamics or the data to turn in favour of a short.  At this juncture he cannot really stomach going long, given the lack of a nearby risk level.  He'll no doubt write about this contract again when things get a bit more interesting.