Market Analogies And Things Worth Keeping In Mind
Submitted by Nic Lenoir
A few things are of particular interest today. First I will start following up on 10s30s and the steepening of the curve. The structures discussed yesterday and last week have finally seen negative premiums today and we saw traders jump on it. In particular the following structure traded: Buy 1.9 x TYZ0 125 Puts / Sell 1 USZ0 129 Puts, receive 1 or 2 ticks (both levels traded). The exact same structure can be done symmetrically using calls receiving a premium as well for those who are not comfortable being short USZ0 puts (this is a curve position, people need to realize that you are not outright short puts).
I had interesting conversations with people discussing how steep the curve can get if hyperinflation gets priced in, or if US treasuries get sold aggressively. Pulling out 10s30s yield spread in Japan and Greece is instructive when thinking of those issues. Japan's 10s30s curve has been in a 35bps/120bps range between 2000 and 2010. Many times like we are seeing in the US right now the curve went vertical, and everytime is came back where it came from about just as fast. Even for those who are believers in further steepening at an unabated pace, based on your directional view on outright rates the possibility of hedging with a positive carry is hard to pass let's be honest. This is just about the perfect hedge for all your QE trades like long commodities, short USD, and long just about anything that has a yield and shorts to squeeze.
The other question comes if people get overly worried about inflation or USD devaluation and there is a flight out of Treasuries. Well Greece does not have its own currency and the problem was slightly diferent, but overall the EUR was butchered from November to July and PIIGS bond were being fled like the plague: the curve flattened aggresively, with 10s30s going ballistic at -4% and more.
I am not worried about that happening in the US even though I am definitely a pessimist. However I think that leaves us with a case where we are closer to what happened in Japan. The key difference is the balance of payments and that's a big one, but should that mean we do not have the rope Japan did and the USD's fall accelerates dramatically, then I think the risk could rapidly turn to hard flattening. With that in mind I think the curve in the US must be played when carry is attractive. One last thing: The curve in Japan has traded quite in sync with the Nikkei's cycles during the last decade. Having a steepener in 10s30s is like being long stock... buyer beware.
That leads us to my second point. While we bypassed the levels I thought would see us top and I walked this morning having thrown the towel, like many other bears it seems, we had an interesting fractal development on the S&P today. First of all looking at the price chart daily, one cannot help but draw a parallel with April 14 2010. The exit outside the bollinger is very similar, and so was the failed topping attempt preceding it. The other noteworthy technical observation is that we had a bullish reversal below the Bollinger band in VIX. That signal betrayed us in September, but amusingly it had occurred on a holiday (Labor day weekend) and that might well be why the price action was to be looked at suspiciously. I still went with it because of the track record of the signal, but it is worth keeping that in mind before discarding today's Vix reversal. I would however recommend caution and wait to see tomorrow if we do get any form of confirmation. At the open Tuesday we had a perfect set-up and the market reversed intraday...
To me this market in general screams deja-vu 2008 all over again. USD is trading very weak, commodities are through the roof, everybody is focused on decoupling, and the ECB is talking hikes when the Fed is in easing mode... You better hope somehow the leading indicators on the ISM are all wrong and it will not go below 45 otherwise... well we all know what happens.
Good luck trading,