Morgan Stanley Goes Short Treasurys.... Again

Tyler Durden's picture

It has not been Jim Caron's decade. The Morgan Stanley rates strategist, riding on the coattails of the always wrong Morgan Stanley economics team led by David Greenlaw, has been wrong in his annual rates call year after year after year. Which is unfortunate because while unable to see the forest for the trees, Caron does have a better grasp of rates than most other Wall Street penguins. That said, just like everyone else in the status quo, Caron has just come out with another short duration call (i.e. sell bonds), probably the 6th time in a row he has done that in the past 3 years. Perhaps 7th time will be the charm. Amusingly, Caron, terrified to be seen in the same camp as Bill Gross who is short bonds on fears that there will be nobody available to step in an buy the 80% of gross issuance that has been monetized by the Fed to date, make this very loud caveat on his short bond call: "To be sure, our shift toward short from neutral duration has nothing to do with the end of QE2 and related concerns that there will be a lack of  demand to buy US Treasuries once the Fed stops buying them. As we have stated many times in the past, the outlook for the economy will be the main driver of yields, not the end of QE2." No, instead Caron believes that the sell off in bonds will be due to the same bullish economic growth call that he has been predicting over... and over... and over... and over... etc. More interesting is how he suggests the trade is implemented: in MS' view the best way to be bearish on rates is with a DV01 neutral 7s-10s flattener: "we continue to recommend being short 5s on the 2s5s10s fly. In line with the butterfly, and in order to  express a more robust short duration position, we recommend a curve flattener on the UST 7s10s curve: · Sell $133.7mm OTR 7y Notes; · Buy $100mm OTR 10y Notes." Perhaps those who want to be short bonds, but for the right reason, that predicted by Zero Hedge and then Bill Gross, this may be one of the better ways to put the trade on.

More below:

Reducing Duration Exposure from Neutral Toward Underweight

We are reducing duration exposure from neutral toward underweight. The reason is that the market has already well discounted 2H growth to levels much lower than consensus. As we see it, the risk now is for the market to price 2H11 growth higher. We will start out cautiously by expressing this negative view via underweighting the belly of the curve versus the wings rather than positioning outright short. The risk to our view is if the European debt crisis worsens, but our base calls for a temporary reprieve as Greece receives a new aid package. This is a tactical view and we believe the location is good to establish a negative UST bias, given how rich the belly of the curve has gotten and since our models indicate 2.85% is the lower bound of fair-value for UST 10y. Medium term, we believe 10y yields will remain range-bound. Let us explain:

1. The belly of the curve has richened to levels that is consistent with a 2.65% growth outlook over the next six months While we feel it is appropriate for the market to discount the risk of a downgrade to the 3.35% consensus growth expectations in 2H11, we believe that discounting it to 2.65% or lower is too much (growth estimates come from Blue Chip Consensus).

2. Our economics team believes that we will have a rebound in 2H11 led by the auto sector that may contribute as much as 1.5% to growth in 3Q11 (see Exhibit 1, LHS) and possibly as much as 0.5% to 4Q11 growth. Also, consistent with their growth outlook, they see core inflation continuing to rise with headline CPI forecasted to be 3.4% and core at 1.9% by the end of 2011 (see Exhibit 1, RHS). However, this view hinges upon the US economy’s ability to produce at least 150K jobs per month − a key threshold.

3. Over the next several weeks, event risks will come to pass and we expect clarity from the end of QE2, the debt ceiling and Dodd-Frank. We believe that this will reduce uncertainty and the safe-haven bid for bonds. Our macro team believes that the recent soft patch is nothing more than a mid-cycle slowdown and that risky assets may perform starting in 2H11 (see Global Debates Playbook, June 16, 2011).

To be sure, our shift toward short from neutral duration has nothing to do with the end of QE2 and related concerns that there will be a lack of demand to buy US Treasuries once the Fed stops buying them. As we have stated many times in the past, the outlook for the economy will be the main driver of yields, not the end of QE2. Also, we think that an agreement will be made on the debt-ceiling debate between the Democrats and Republicans some time in July before the August 2 social security payment deadline. And as for Dodd-Frank, which is scheduled to start imposing new regulations on the market as early as July 16, we believe that much of it may be postponed until later this year and possibly into 2012 due to the lack of clarity around many of the intended regulations.

Following the money. As the market is priced for slower growth over the past several weeks, we have seen inflows into bond funds rise sharply while risky assets saw outflows (see Exhibit 2). For the month of May, bond funds saw the largest monthly inflows in seven months totaling $20.2 billion while equity funds saw outflows of $2 billion as compared to inflows in April of $5.3 billion (first month of outflows after six consecutive months of inflows). Also, according to surveys we follow, the decline in rates has caused many to reduce their short positions. Thus the combination of money flows and duration surveys we track indicate that the short bond exposure in the market has been reduced which technically puts less pressure on rates to stay low and instead clears a path for them to rise.

Duration risk cuts both ways. When growth expectations for 2011 were being downgraded, longer-duration bonds performed best. This was most notable in TIPS as real yields significantly dropped. The drop in real yields was so dramatic that the year-to-date performance of TIPS even exceeds that of high yield. What has changed? Long-duration exposure presents a greater risk and may become a source for underperformance rather than outperformance going forward, especially if 2H11 growth rebounds as market consensus suggests it might.

Conclusion. Our tactical shift from neutral to short duration has several implications: 1) we expect real yields to begin a steady rise higher, and 2) we expect the belly of the curve to underperform and the 10s30s curve to flatten.

And the best way to express a bearish stance in the rates complex according to Caron:

Since April, the belly of the curve has richened significantly as rates have marched lower (Exhibit 1). We continue to recommend being short the belly vs. the wings, as previously discussed short 5s on the 2s5s10s fly (see “Fade the Recent Outperformance of  the Belly,” US Interest Rate Strategist, June 9, 2011). In line with the butterfly, and in order to express a more robust short duration position, we recommend a curve flattener on the UST 7s10s curve:

· Sell $133.7mm OTR 7y Notes

· Buy $100mm OTR 10y Notes

Both the 7s10s curve flattener and the butterfly allow the investor to play for a reversion in the richness of the belly. Rather than going outright short we suggest initiating these relative value trades, which capture some duration exposure and some relative  value exposure between different points on the curve.

We argue that growth expectations have not been downgraded to the extent that rates in the 5-10y sector have fallen with survey consensus at 3.35% for 2H11. In our view, the rates market is pricing levels of US growth that are inconsistent with surveyed forecasts (see “Reducing Duration Exposure from Neutral to Underweight” in this publication).

This past week, price action in the market has reflected uncertainty as, for example, the 7y point increased 12bp on Tuesday only to decrease by 14bp on Wednesday returning to similar levels. We expect the market to remain range-bound in the near term; however, we see fair value of the 10y note at about 3.10% with a 25bp standard deviation (Exhibit 2). With the 10y dipping to the low 2.90’s, we see an opportunity to fade this extreme.

UST 7s10s Flattener

As we have shifted from neutral duration to tactically short, we seek relative value trades that would perform if yields in the belly increased. We believe a UST 7s10s flattener is one of the best trades that fit this description for the following three reasons:

1) Historically steep curve. We have been in a steep yield curve environment for some time now, but with the recent move lower in yield in the belly, curves such as 5s10s and 7s10s have increased once again and now are nearing the all-time highs reached in November of last year (Exhibit 3). We do not think that the low yields around the 7y point are warranted due to growth expectations higher than they were 8 months ago, and hence we look for this curve to flatten.

2) Beneficial roll and carry characteristics. The 5s10s curve historically has more variance than 7s10s, however both curves have increased approximately the same amount over the last several weeks (Exhibit 4). Additionally, the carry on the 7s10s flattener is -2.0bp per 3m, while it is -4.5bp per 3m on 5s10s. If we divide this carry by the 3m realized volatility of each respective curve, we obtain a carry quotient of -0.24 and -0.36 for the 7s10s and 5s10s flatteners, respectively.

The carry quotient gives us a risk-adjusted level of carry on each curve and shows us that the 7s10s absolute carry of -2.0bp is also better than the 5s10s negative carry on a risk-adjusted basis.

3) Correlation that favors a sell-off in the belly. Our premise is that we are not only fading an extreme curve level, but also gaining exposure to a sell-off in the 7y sector. Recently, that is exactly how this curve has been trading

7s10s has been fairly well correlated with rates since about January, 2010. Starting in October, 2010, this correlation increased, and the beta, or slope of the regression increased as well. Since October, 2010, the 7s10s curve has been flattening/(steepening) approximately 13bp for every 1bp increase/(decrease) in the 7y yield.

The risk to this trade is that the 7y yield decreases relative to the 10y yield. As the trade involves a short position at the 7y point, losses are potentially unlimited.

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firstdivision's picture

Guess the discount window will be closed to MS soon.

bonddude's picture

But the "Real Housewives of Wall Street" are still doing good. ;-)

SparkyvonBellagio's picture

Kids fined over illegal lemonade stand at USOpen. Nice way to influence kids and break their spirit early. 

This kind of crap SUCKS!

cougar_w's picture

Ha ha. Can you spell "desperate county in bankruptcy"? Suck it up.

Oh and you better pay your outstanding parking citations too or they'll chopper in a SWAT team on your narrow ass.

FOC 1183's picture

7s10s flattener.  AKA watching paint dry.

Sudden Debt's picture

This is a good lesson for our kids: ALWAY BITE THE HAND THAT FEEDS YOU!



Bam_Man's picture

The only reason this clown Caron still has a job - and has not defenestrated himself - is because he is playing the game with OTHER PEOPLES' MONEY.

HelluvaEngineer's picture

OT: think Tyler better get the deer picture ready....

cougar_w's picture

What? You think the Dow will go below 12K? Ha! Well you have not seen these men in action. The 30 minute drill today will be epic. Monumental. Your eyes will bug right out of your head, they will.

SheepDog-One's picture

Or, the DOW may finish down -200...who knows? Who says that want the DOW up every day, do you have the Pigmen's short and long positioning ratio?

cougar_w's picture

Surely it has less to do now with positions and so much more to do with the entire planet not catching literal fire and burning to ashes by Tuesday. Or something even worse, like senior haircuts.

eureka's picture

Oh yeah?

20 min.s to closing S&P up .19%....

Highrev's picture

Euro Stoxx 50 futures, heavily financial weighted, still hanging on to +2% on the day.



SOX taking a beating again. (Full 50% retrace of the move off of last summer's low BTW, and oversold on all time frames from the 5 minute out to the weekly.)

eureka's picture

First pump, then dump.

cougar_w's picture

Completely OT:

Morgan and Stanley as a running gag:

Does anyone have a UTube link to the proceedings from the House Oversight Committee Investigating the Guttman Sacks and Morgan/Stanley Economic Data Catastrophe? Cuz I wanna see Morgan go all mayhem again on that peckerhead from GS.  I was loled.


Cognitive Dissonance's picture

.........Caron does have a better grasp of rates than most other Wall Street penguins.

Looks like Caron has a broken nest egg.

SheepDog-One's picture

America will fall in 1 day. Try to time that right.

cougar_w's picture

Hey now, timing this market is no more difficult than to catch a falling knife ... with your tongue. While in a straight-jacket and roller skates. As your leg is being chewed off by an angry mob of rabid ferrets even as Ben Bernanke is lecturing you at length concerning his expectations for inflation.

Nothing hard about it at all.

You need to get over your pessimism my friend.

eureka's picture

The whole world will go Greek -and that's positively positive.

Of that, I am positive.

Let's all be positive.

It's very positive.

I'm an optimist.

US Globa-Fi-Scum collapse IS a blessing for the whole world.

Count Down: 12 months. Enjoy.

sbenard's picture

Meanwhile, Morgan Stanley has my mother long treasuries! Her 29-year-old account manager persuaded her to continue to hold them, despite my urging her to liquidate them, telling her they weren't sure they COULD sell them!

Cognitive Dissonance's picture

You can always sell least for now. What she was probably being told is that she couldn't sell them without taking a loss. So the broker continues to tell her "if you hold to maturity you will receive all your principal back plus all the interest along the way" know......the USA is good for it.

This is why I suspect the government will never 'default' in the technical sense. They will simply inflate it away. We still haven't entered the inevitable hyperinflation phase. Who knows what happens in between. It's the end that ultimately matters to all of us unless we don't plan on living through it.

BTW not living through it is increasingly being seen as a valid strategy by some.

cougar_w's picture

BTW not living through it is increasingly being seen as a valid strategy by some.

It takes a stong man to admit he's been lied to.

SheepDog-One's picture

Theyre working hard to keep all 401K pensioners from cashing out by fear stories they'll lose money. Got to keep the pensioners calm until the rug is pulled out and treasury can seize all those trillions.

And who says theres the option of 'living thru it' in the first place....what are IPhone americans suddenly all Jeremiah Johnsons?

Cognitive Dissonance's picture

And who says theres the option of 'living thru it' in the first place....

That is the ultimate denial....isn't it.

In good times and bad we all have a tendency to hang on to the idea that of the 90% who will suffer we will be one of the 10% that prosper. Living the inauthentic life really leaves us no other option than to lie to ourselves. Any wonder then why we as individuals and as a social order so readily accept liars, thieves and rapists as our leadership?

cougar_w's picture

I'm not sure we accept them as much as we created them in our own image all along.

But the distinction does not alter your core premise. So, yeah.

Cognitive Dissonance's picture

To say that we create them in our image is actually the core of many of my articles. But it's easier to swallow if I just say we 'accept' them.

In many cases I'm trying to get people to accept 'radical' ideas here Cougar. It's one thing to say this in an article many just ignore, another entirely to say it in a short comment. 

Baby steps. A year ago my comment would have received 5 junks. I see this as progress.

cougar_w's picture

I junked you, for old times sake.

Caviar Emptor's picture

what are IPhone americans suddenly all Jeremiah Johnsons?

Meme of the day

eureka's picture

The end is right now - and it is liberation - achieved by not identifying with or depending on the empire of leverage and bamboozlement.

Free spirit, self-reliance, mobility.

Fuck the empire.

Boston's picture

Morgan Stanley?  To buy/sell Treasuries?

They "charge" full point+ spreads and then they thrown the "commission" to add insult to injury.  

Get away from MS.....they're stealing you mother's money!


P.S. Here's my painful lesson: Using MS (over a decade ago) I bought a seven figure sum of 10-year notes.  One month later, after the price moved up 2 full points, I called my Morgan Stanley broker to sell and book my "gain".  When I got my confirm, my jaw dropped---Morgan Stanley kept 95% of the price movement, leaving me with peanuts.  When I called to ask how they could do this, my broker said that the trading desk "needs to make money too"!!  I dumped them immediately.  Fucking thieves.


cougar_w's picture

But be fair. That was ten years ago!

j/k they really are fucking thieves.

Coke and Hookers's picture

Does any Wall Street analyst at all see any distinction between the artificial world of bullshit/derivatives/money printing they live in and the part of the economy that produces actual wealth? I'm not sure I've ever seen any person employed by a bank ever refer to something real in his or her analysis. Fucking tards. I think I'm going to get drunk right now.

narnia's picture

does any "mainstream" keynesian economist view the development, manufacture and deployment of a bomb any different from the development & deployment of nutrition, provided it has the same effect on GDP?

how about the resources spent hiring of a cop, a judge, a prison guard, a prison complex,  dehmanizing of a whole segment of our society, and destabilizing every nation south of the US?  would eliminating all that crap from GDP be a bad thing? 

until US GDP actually measures the quality of life of Americans, the whole narrative by which our economy and financial system is judged is seriously flawed.    


Coke and Hookers's picture

"until US GDP actually measures the quality of life of Americans, the whole narrative by which our economy and financial system is judged is seriously flawed. "

The real measure of the (economic) quality of life is wealth - what people can actually afford to buy and own - not what they can borrow to buy. Most economic indicators don't measure that at all. The dialogue and analysis in the business press don't even take that into account and it has become irrelevant. Real production of wealth has been shrinking massively and is made up for by debt. The debt results in loss of assets by the people through bubbles/bankruptcies/currency devaluation. Everybody is broke and the economy has been deindustrialized. Do the economic indicators used by the government and Wall Street measure that? Let's look at two scenarios:

Scenario one: Let's say I buy a bag of oranges from a Florida farmer for $5. I sell it to Narnia who sells it to Caviar Emptor who sells it back to me. Somewhere in the process Caviar Emptor sells a mark to market CDO based on the oranges to Tyler. I buy the bag back for $25 and hire a minimum wage slave to sell it for me for $40 to someone who puts it on his credit card. I had to take a loan to buy the bag back and Tyler bought the CDO with borrowed money. We're talking serious economic activity here that contributes perhaps x5 as much to GDP than the farmer got for the orange bag in the first place.

Scenario two: I buy the bag for $5, go home and eat the oranges myself.

Question: Which scenario is better for the economy? A measurement of which scenario is more accurate for measuring GDP?

My point is that you can cut real production of wealth in society by half but still show growth based on bogus value add and debt. You can create a whole, vibrant economy around a fucking bag of oranges and some creative financial instruments to help you out. You can even grow while the orange bag shrinks by half.

narnia's picture

my definition of wealth is the ability to maintain a high quality of life, spending my limited time in this life doing what I want with the people I want rather than spending my time earning what my family & I need to survive.  

when the state spends money purchasing bombs & prisons & regulatory agencies that have no value to me on my behalf & finances those purchases through borrowing or printing money, it imposes tax.  it is this tax that has a material impact on price.  your example of the price impact of financing methods, irrespective of how flawed the fiat fractional reserve system we have is, is wildly exhaggerated.  

Sherman McCoy's picture

Short bonds has go to be the dumbest trade of the last decade. The U.S. is going through what Japan did, and as long as Fed Funds are anchored at zero, bonds can't get much above 4%. Wake me when the Fed tightens.

narnia's picture

Rates rise in stagflationary periods not because of an increase in demand for credit, but because of inflationary monetary policy.    

buzzsaw99's picture

imo he is wrong and for all the wrong reasons (the perfecta) or he will be right (over the shorter term) for the wrong reasons. A broken clock is correct twice a day, maybe Caron will be correct once a decade.

bogey4's picture

There is almost no way she could be at a loss - rates are at virtually the dead lows for the last 30 years.  The guy doesn't know wtf he's talking about. 

If she (you) really want out, call him and tell him to sell 'em.  If he tries to put too much commission in the trade (there should be almost none) tell him you want to talk to his manager and then the NASD.

buzzsaw99's picture

buh buh buh bankRATE bitchez!

dcb's picture

I have been trading tbt, tlt. for the past two months making money both ways. today my tbt is up, because tlt was over sold. for gods saake, draw a speed line on tbt, and if you buy at the last low, you will almost always have a good trade.  and the rsi says you should be short treasuries. but it doesn't matter to me, because I'll make money either way trading tbt, tlt. no position is firm, if I just trade the speed line

tony bonn's picture

"As we have stated many times in the past, the outlook for the economy will be the main driver of yields, not the end of QE2..."

bbbwwaaahahahahahahhahahahhahahahahhahaahhhhaaaa! what a fucktard. say anything to protect bankster myths and lies...

so it is the outlook - not the economy per se - which will drive everybody mount your skittle shitting unicorns and dump barrels of pixie dust to keep bond yields up....make sure to tune into your favorite news whore who will tell you any sweet nothing to keep your outlook up and hence keep bond yields low so that the verdant green shoots can continue to grow....

and if that doesn't do it, the indonesian-in-chief will wag his finger at you so that you will keep your outlook positive...

or will a positive outlook cause rising rates because the economy is growing too much? hmmmm...what a riddle...

Caviar Emptor's picture

Ahh yes, Biflation is sooo hard to grasp when you cling to quaint old school notions. The old rules of economics simply are no longer applicable to this new world of terminally distorted markets, trying hard to ignore the rules of supply and demand. Yes, Virginia, there is deflation mixed in with inflation. The grown ups just don't get to see that

firefighter302's picture


Let the buyer beware. (seafood buyer?)

Downtoolong's picture

Perhaps 7th time will be the charm.

If you stick to your story long enough, it will eventually come true. Then you get interviewed by Maria Bartiromo and a multi-million book deal.

It's only when you keep changing your story that you run the risk of being wrong all the time. Just ask Cramer. 

Buck Johnson's picture

They know whats coming, the bubble of treasuries is about to burst.

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