We have often discussed the use of the Treasury 2s10s30s butterfly as a carry tool and it makes sense that primary dealers would proxy this in their inventories to earn a much more risk-managed carry than a simple curve trade from a net interest margin perspective. With MF Global drawing down its credit lines and facing immediate stress, it also makes sense that they would look to sell down any and every holding they had in order to show liquidity. In the 24 hours from mid-day Wednesday to mid-day Thursday the 2s10s30s butterfly experienced one of its largest ever shifts higher (unwinding the carry trade) at over 4 standard deviations and only matched by moves in Q4 2008 (LEH?). Equity markets tracked this massive and unending rise in 2s10s30s almost tick-for-tick which we think explains how such a no-news summit in EU can create such a massive move in US equities. Moreover, the attractiveness of the 2s10s30s butterfly is reappearing up here and it is compressing suggesting stocks have room to fall here.
This shows the 1-day moves in 2s10s30s with the red dot indicating the 24hr period move from Weds to Thurs this week - over 4 standard deviations.
The shift up in 2s10s30s from Weds to Thurs was incredible in size and very notable for the hyper-correlation with ES. Today sees the low volume equity range holding up as 2s10s30s starts to get bought again (for carry) suggesting equities have some downside risk here.