A week ago everyone was convinced that in three days, Bernanke would reveal the second coming or whatever the equivalent biblical event is these days that would send the Dow to 36,000 in a heartbeat. We laughed at such naive suggestions. Then over the past five days the market has seen a profound transformation with what was initially a seed of doubt that the Chairman may in fact disappoint his stock buying disciples, having sprouted into a full blown weed of outright denial, fear and loathing. Which makes sense: in a world in which everything is jawboning, everyone's hope is always on the event just over the event horizon, but never on the one that is imminent: that way when the inevitable disappointment happens one can just say it was all premeditated and is coming "next time." However, in case the market has finally had enough of being led by the nose, lied to, and does throw a temper tantrum, there are way to take advantage of this. One bank that suggests just a way to do this without trading in that insane asset class known as stocks, where up is down, down is purple, and the triangle-square-square-circle killer combo sequence now works in reverse, is Credit Suisse, which suggests to put on a short bond position in anticipation of a major selloff which should inevitably accompany a disappointment from the Fed. Their suggestion: put on a $50K DV01 short at 1.64% and expect a steep selloff when the Fed disappoints, with a 1.75% target. If all works out according to plan, everyone involved should be $500,000 richer at market close on Friday with Bollingers all around.
If history is any guide, CS is right, and this will be the easiest $500 grand ever made. Then again, if there is one thing central planning has taught us, is that under central bankers with no world experience, history never rhymes.
From Credit Suisse:
As has become tradition at this point, considerable anticipation has been building around Chairman Bernanke’s upcoming speech at the Fed’s annual Jackson Hole conference. With all of the chatter around whether the Fed is going to announce further easing at the next meeting, Bernanke’s every word will be scrutinized to glean any indications of the direction in which he’s leaning.
While it is not uncommon to remember Jackson Hole as the venue for some of the most important announcements in the recent policy history of the Fed (remember QE2?), Bernanke has more often than not been loath to make any type of strong commitment.
Even the 2010 speech can be better characterized as a discussion of the options at the Fed’s disposal—a far cry from the “QE2 announcement” that it is often remembered as being.
In all, regardless of our wistful memories of the Chairman coming to the rescue in Wyoming, history shows us that whatever expectations may be, the speech often ends in a sell-off.
With this in mind – and following on the back of the current low-volume re-rally in the market – we recommend taking a tactical short into Friday’s speech. We add a $50,000 DV01 short in the current 10-year note (yield of 1.6400% at the time of this writing) to our model portfolio, targeting a short-term back-up to 1.75%. The risk is that 10s break from their usual behavior around Bernanke’s speech and continue their rally. Note that we remain medium-term bullish with a 1.35% year-end forecast for 10s.
Below we show the average movement in intraday yields on 10s for the week of Bernanke’s speech going back to 2008, along with the movements for each speech day. Although the behavior leading up to 10 a.m. differs year to year, 10s have consistently sold off, jumping 7bps on average during the day on Friday. Much of the move occurs in the initial moments
And the empirical evidence behind CS' thesis: