Dear muppets: Goldman wants you to short TYM2 (reminder: a key axis? check; elephant hunting? check; three letter acronym? check). Translation: every bond you sell, Goldman buys.
Last night’s FOMC statement ‘marked-to-market’ the committee’s assessment of US economic conditions, which continue to gradually improve. Attention now turns to the minutes of yesterday’s policy meeting, which may reveal whether easing options were contemplated after the expiration of ‘Operation Twist’. US Treasuries sold off yesterday, and are now breaking above the yield range in place for many weeks. The 10-year US-Germany differential, now at 40bp, is at the widest level since last November. A wider spread is in line with our valuation metrics. But the level of intermediate yields remains about 25-50bp too low on both sides of the Atlantic. Using 10-year bond futures (TYM2), we would recommend short at 129-17 for a target of 126-00 and tight stops on a close above 131-16.
Financial economists make a distinction between ‘uncertainty’ and ‘ambiguity’. Loosely speaking, uncertainty has to do with what we colloquially call ‘known unknowns’ and mostly pertains to the shape (or ‘moments’) of a given distribution of possible future outcomes. How ongoing tensions related to oil prices may affect future consumption and inflation provides an example: we can resort to historical precedents and attempt an answer. By contrast, ambiguity evokes the idea of ‘unknown unknowns’, or risks that are not susceptible to ex ante quantification. The current Euro area banking and sovereign crisis has raised many uncertainties, but is predominantly a story of ambiguities. This distinction, which may appear academic, has actually important implications for asset pricing. Below we illustrate this point in relation to Italian and Spanish sovereign spreads to Germany.