These are huge steepening positions getting thrown on. Check the TUT spread - just broke 50-day moving average after 2 years in sharp decline. Maybe later I'll try post some charts. Meanwhile if someone beats me to it, would be appreciated ...
Hi Mcurto, They are finally realizing long-term rates are going to rise. After sitting for months saying that "It's normal for yields to be flat" It's a new era! Justifying what is abnormal, is not normal. And should be considered a new error. Which obviously it was! We started this post on January 18th. We've done a good job guys CONGRATS! Mcurto, appreciate your continuous great insights. And, your Japanese guys won't see their puts go down the drain this time. They were right on too!
Actually, as usual the Japanese guys got out of their puts too early, or at least a portion of the 30yr puts, but out of all the May 106 puts in the ten year before it broke that handle. Way too early on those. Oh well, it has definitely been fun now that we have started to break out of that long end range. Lots of volume on this move, 800,000 ten years on a holiday session on Thursday, that is good size. Should be plenty more to come.
It's too early to dismiss the persistent influence of new elements such as Greenspan's conundrum and pension funds' voracious needs for long term bonds. Interest rates are still low by historical standards and the yield curve is almost flat at a time commodity prices are exploding. <img src="http://charts3.barchart.com/custom/stocks/4604.gif"/>
Which means the Fed needs to lift short term rates further, and hold them there longer, than the market has been pricing in - i.e. long end rates must start rising and the 'conundrum' unwound. More simply put, at minimum the curve-flattening trend is over. Whether we've just entered a steepening trend is anyone's guess, but it is likely a high-probability trade that many are putting on, based on what mccurto has posted.
Many pundits and economists have been predicting economic slow down or recession later this year. Is it possible that long term interest rates could possibly stay high during a recession on the long end of the yield curve if commodity prices keep flying? How would the yields change in a possible stagflation scenario. I would think the curve would steepen as the fed cuts shorterm rates and the 10-30 years rise on inflation fears.
<b><font>IGNORE THAT GRAPH</font></b> Ignore the graph shown above in my last post (three posts up). I posted a link to a CRB Index chart at barchart.com that has been changed and that is now associated to another chart.
The two kinds of economic forces that flatten and steepened the yield curve both lead to tighter monetary policy. The 'conumdrum' that <font color=blue>flattened the curve</font> makes monetary tightening less effective and forces the Fed to make additional interest rate hikes; and the build up of an inflation-risk premium that <font color=blue>steepened the curve</font> forces the Fed to respond to inflation worries. Once the Fed takes appropriate action with stiffer or more rate hikes, the yield curve will flatten again.
My take on this whole process, is that the fed keeps raising in 25bp increments for at least another 2-3 rate hikes over the summer. The CB has targeted asset prices and the economy and is going to keep hiking until things start to look soft, at which time they will stop and then after a while, start ratcheting down the short end, but much more slowly and much less than they ratcheted up. This will keep the curve flat to steepened, with the long end re-exhibiting a risk premium, which it is showing the beginnings of. How to get the risk premium back? Raise until it hurts and defaults burn a few bondholders. You'll want more premium for your risk after getting singed in the fire, no? My gut feel, which I can't really substantiate, but I think is right (and have acted accordingly), is that our new fearless leader, BSB, along with Alan's complicity, has been raising slower than imputed inflation influences (c.f. commodity run up) and might have quite a bit more to go on the short end than we all think, particularly if he is willing to pause for a while before further raising (which might be a favored maneuver before the mid term elections). This allows for inflationary influences to come into the economy, providing the 'inflation targeting' function that BSB is so fond of, while raising nominal interest rates (but not real). So, I think that as long as you are short right now, you can't really go wrong. Once there is a pause, particularly if at that time commodity prices are sky-high and look like they want to fall, I'll change my mind on the short end and ride that down with gusto for about 200bp. However, its very hard for me to think about doing anything other than shorting the 30 year until yields are at least 6%, and more likely 8. Yes, this is a long-term structural short position, although in the back of my mind, I still think about buying some 25 years and holding them to maturity at 6% yield or above, not so much as a position play, but for their stabilizing effect on my portfolio. I have learned something from this discussion - mccurto, your comments are sometimes over my head, but still appreciated.