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Guest Post: Careful With 30Y Treasuries

Tyler Durden's picture





 

Submitted by Bo Peng 

Careful with 30Y Treasuries

With Fed announcement of the second round of treasury purchase in the
2-10Y segment and corresponding yields at all time lows, it may be
tempting to pick the only cheap thing left in this space, the
longest-term treasuries. It seems natural to speculate that the 30Y will
follow, and the next natural thing for Fed to do should be buying the
30Y.

Well, every obvious play in the market comes with some
caveat. The more obvious and sure thing it seems, the more worried and
paranoid you should be.

A few risks I can see about this seemingly obvious play.

1. Big players may be tempted to do a curve steepner between 10 and
30Y, long 10Y and short 30Y or some variations of it. Such bets paid off
handsomely in 09, then lost spectacularly since this April but if big
money piles on again, it would tend to drive up the 30Y yield.

2. One rationale behind a curve steepner trade, and a big risk for long
30Y, is inflation expectation. Perpetual stimulus and bailouts will
quite plausibly drive up inflation at some point in the future, and Fed
will be heavily biased to act too late rather than early against
inflation when it happens. And hyperinflation, if and when it happens,
tends to be in the typical black swan fashion -- sudden, violent, and
unpredictable in timing and scope.

3. Fed may be politically constrained in going further out the curve to buy treasuries.

4. Usually, the longer the maturity, the more interest rate risk or the
higher the leverage. This is usually a major rationale to buy 30Y if
you want higher leverage. But, because the curve is already so steep
between 5-10Y and 30Y, the deltas (interest rate sensitivity) are about
the same. In fact, gamma for the 10Y is higher (more negative) at
current levels, meaning that if yields decrease more (say 1% instead of
1bp), the capital gain on 10Y is actually higher than on 30Y. This makes
30Y less sensitive to rates, which is counter-intuitive. But the
inflation expectation is such that the curve may not shift up in
parallel (see point 1 above), and the 30Y bet could be a lose-lose
compared to 10Y -- if inflation shoots up, 30Y loses more because yield
goes up more at the long end; if deflation kicks in, 10Y gains more
because of higher convexity. And this is why the curve steepner is
tempting to begin with.

I try to constantly remind myself of
the LTCM bets and the Merrill bond-CDS basis bet and think thrice about
any obvious trades. And if you can't think of how it could fail, you'd
be safer to simply assume it's a trap. Unless you're trading other's
money and get paid on relative performance basis, you can always better
afford to miss some opportunities to make money than lose money.

1. There's always another opportunity somewhere else, down the road.
2. If something seems too good to be true, it probably is.
3. There's no free lunch.

Well, free lunch galore if you have discount window access or otherwise
win the government random bailout/handout lottos. The New American
Dream makes winning lawsuits look way too tedious and low on ROI and
Sharpe ratio, except the Old American Dream is morally far-superior on
relative basis. Forget about McDonald's hot coffee, people. That's so,
like, pre-crisis and amateur. Just stop paying your mortgage and credit
card and student loan and the money you borrowed from mom in senior
center, or better yet, join TBTF. Sooner or later our central-planning
state-capitalist commiekaze government will help you out.

Disclosure: Long 5-10Y TIPS and treasuries

 


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Mon, 08/16/2010 - 19:43 | Link to Comment bugs_
bugs_'s picture

Bo knows.

Mon, 08/16/2010 - 20:02 | Link to Comment NoLongerABagHolder
Mon, 08/16/2010 - 22:11 | Link to Comment DarkMath
DarkMath's picture

"Printing alone will not cause massive inflation. The spending of printed dollars will."

True, spending those dollars the Fed conjured into existence would cause inflation. But you're missing something: the other part of the Supply/Demand equation. Your talking about the Supply of Dollars, what about the Demand for dollars? Inflation could be caused by an increasing Supply OR a decreasing Demand right? So if our creditors fear a default in a deflationary environment then they will dump dollars.
So your argument is only half right. What you miss is calculating how our creditors will react, will they always have faith? Since that is a psychological question we've left the realm of Economics. Nonetheless the answer still has a direct impact on where things are going. Given that no one can answer that question I'm going to punt on the Equity AND Debt markets and go into Commodities like Oil, Food and Precious Metals. They don't lie and they're all going through the roof in the next 10 years.

Mon, 08/16/2010 - 20:51 | Link to Comment johngaltfla
johngaltfla's picture

Agreed. This is a trap waiting to snap your nipples off. It's gonna be painful for those suckered into it thinking the Fed will sustain any long term purchases past the election. Add salt and vinegar to the wounds and the curve blows back out and steepens rapidly.

Mon, 08/16/2010 - 22:02 | Link to Comment jeff montanye
jeff montanye's picture

so if not past the election we are talking a good two months, right?  the last time the long bond traded at the current level coming down, it was at about 2.55% a month later, in an environment of equity weakness.  that's a trade worth making.  of course when one thinks one has the key to the market, it changes the lock. 

Mon, 08/16/2010 - 23:04 | Link to Comment Not For Reuse
Not For Reuse's picture

only way the 10/30 steepens is if the 10 goes apeshit. It's fucking math plain & simple, the fed can try to pretend they have fuckall to do with it but it's purely posturing.

Mon, 08/16/2010 - 19:49 | Link to Comment swanpoint
swanpoint's picture

Au BITCHEZ.

Mon, 08/16/2010 - 19:53 | Link to Comment Dismal Scientist
Dismal Scientist's picture

Bond market says 'We'll be herded, but there's an arb in the meantime'. GET ME OUT

Mon, 08/16/2010 - 20:03 | Link to Comment trav7777
trav7777's picture

I'll bet money that they flatten the 30 too.

With mortgages indexed to longer-duration bonds, there is really no choice here to lower "real world" interest rates.

The whole spread function mandates it.  It's the last thing they can really do to try to spur lending.  Collapse all rates in all durations and hope that people are motivated by 2% mortgages and shit. 

Why?  Because DEMAND by US for credit of any duration has waned markedly.  So they will try to sweeten the deal.

Mon, 08/16/2010 - 20:29 | Link to Comment Eternal Student
Eternal Student's picture

That's a superb point. Some Economists in the RE biz (with PhD's even) were predicting that interest rates would go up in the Fall. They're looking even more silly now.

But if Real Estate is declining by 10% YoY, that 2% mortgage becomes very expensive. Especially if you're putting skin into the game.

In order to pull this off, they'd somehow have to convince people that last Winter/Spring really was the bottom of the Housing market, and not just another mini-bubble blown by the Fed. That's going to be harder to do in the next couple of months, IMO.

Mon, 08/16/2010 - 22:06 | Link to Comment jeff montanye
jeff montanye's picture

you and trav make excellent points:  why the fed may do it and why it likely won't work.

Mon, 08/16/2010 - 22:34 | Link to Comment -1Delta
-1Delta's picture

Agree, other than the duration on the 10yr is greater than the 30yr (mathematically speaking).

But it will flatten... the reality is that low rates do not fix a fukin haircut on an expensive house. But trade that direction

Mon, 08/16/2010 - 20:03 | Link to Comment Magua
Magua's picture

Understand the worry, but making 20% in a year to year and a half is worth the risk. The fallout comes later, 2012 ish

Mon, 08/16/2010 - 22:13 | Link to Comment DarkMath
DarkMath's picture

Extend and Pretend all you want. I'm heading for the lifeboats.

Tue, 08/17/2010 - 05:00 | Link to Comment Thorlyx
Thorlyx's picture

Lifeboats, bitchez !

Mon, 08/16/2010 - 20:04 | Link to Comment mynhair
mynhair's picture

Didn't the Fed amend their statement to include 30-yr purchases?

I always trust the Fed.

Mon, 08/16/2010 - 20:04 | Link to Comment Buttcathead
Buttcathead's picture

I aint buying nothing.  It's all too rigged.

Mon, 08/16/2010 - 20:12 | Link to Comment ZeroPower
ZeroPower's picture

Said in the other thread on USTs and will say it here, using long-dated swaptions will save your ass from the guys upstairs (or downstairs if its the turds in risk mgmt!)

Mon, 08/16/2010 - 20:13 | Link to Comment Oswald Spengler
Oswald Spengler's picture

TBT 3X daily volume today.

Mon, 08/16/2010 - 20:20 | Link to Comment Monkey Craig
Monkey Craig's picture

Good call....the retail investor is only interested in bearish bets.

Hamid Gul was on Alex Jones today. Sign of the times.

Mon, 08/16/2010 - 20:46 | Link to Comment Justaman
Justaman's picture

Is this all for real?  Is this really happening?   

How did we get to this point of no return and who is okaying these cataclysmic decisions? 

Are the only buyers of Ts really the UK, Fed, and banks?  Are we all expected to ride this bitch down? 

I know these are all rhetorical questions but I really have to write them down once in a while, you know, as therapy. 

 

 

 

Mon, 08/16/2010 - 22:08 | Link to Comment hamurobby
hamurobby's picture

How did we get to this point of no return?

 

Well lets see, someone thought it a great idea to repeal the head tax...or was it the first federal bank... well anyways, we are finally here! You know, that point we all talked about twenty years ago where we were going to have to pay for it all, wow time flies.

Mon, 08/16/2010 - 20:54 | Link to Comment gringo28
gringo28's picture

No, Cu cracker

Mon, 08/16/2010 - 20:55 | Link to Comment gringo28
gringo28's picture

No, Cu cracker

Mon, 08/16/2010 - 22:32 | Link to Comment BernankZZZ- Again
BernankZZZ- Again's picture

Well I have certainly done my $ on the TBT idea:( ,How can you double US dollars, run up huge deficit's, commodities at high levels and not have some sought of inflation. I am tired of trying to be smart now I may go and pour myself a scotch and watch from the sidelines.

Mon, 08/16/2010 - 23:33 | Link to Comment whatsinaname
whatsinaname's picture

How about 2012 puts on TLT (OTM) instead of outright TBT ? Let the leverage work for you and not against. TBT could be ground to death by central bank / big bank shenanighans..

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