I was wondering if someone could help me.
I had a question about using ED’s as a proxy for trading the US yield curve and hope this is the right place for it.
I read an interesting blog which discussed potential steepner trades on the 2s10s and 5s30s as the yield curve continued to flatten. The trader was looking to hold this for some time as a macro play and another trader asked why he didn’t just trade the ED Z8Z9 or Z9Z0 instead. The OP seemed to like this idea.
This lead me to wonder if the ED works as a good proxy to the US yield curve but without the need to roll each quarter like you would with treasuries. I had 2 concerns with such a trade though:
1) Wouldn’t treasuries offer more security than EDs in a financial shock/crisis – leading to unexpected behaviour in the ED spreads which could negate the trade and our idea completely?
2) If the idea is to trade the yield curve between the short and long ends, why would 12m EDs be a good proxy? Wouldn’t you trade EDZ9 vs EDZ7(2027 code?) as a 2s10s proxy?
Thanks in advance.
1) The dynamics of spreads are complicated... It's a can of worms and it would take a long time to describe all the relevant aspects of doing a trade like this.
2) Yes, the idea that EDZ8-Z9 or Z9-Z0 is a good proxy for the UST 2s10s or 5s30s slope is an approximation too far, IMHO. While there undoubtedly is a correlation, the relationship is far from stable (in fact, if you do your regressions of the rolling reds-greens ED slope vs constant maturity 2s10s UST, you'd find that the Rsq has been steadily going down in recent years).