Coiling, Complacency, And The "Three" Coupon Treasury Markets

Via Guy Haselmann of Scotiabank,

On the Cusp of Breaking the Ranges!?

On a closing price basis, the trading range for the US 10 year note since January 24th has been 22 basis points which is the narrowest in that length of time in over 30 years.

The FT reported today that the 7% range in the dollar over the past two years is the narrowest over that length of time since late 1977.

Despite huge intraday volatility in Q1 in various single name equities and sectors, the FT also says the trading ranges for broad market equity indices this year have been the narrowest in over a decade.

Often times, narrow trading ranges act like coiled springs.  The longer markets stay in those ranges the greater the pressure builds.  Tight ranges over longer time periods cause ever-more-powerful movements once the ranges break.

Over the next two weeks, there are multitudes of events and economic data which could set the tone of trading for the next several months and potentially provide the catalyst necessary for markets to break out of ranges.

A vast amount of important US economic data burdens the calendar the balance of the week.


There are also month end influences;


an FOMC meeting and Bernanke speech tomorrow;


and, ECB, BoE, and RBA meetings next week.


Holidays in Europe and Asia this week could further exacerbate poor market liquidity and serve to magnify price movements.

There are several factors contributing to market complacency:

Share buybacks help fuel a relentless stock market bid (buybacks totaled 6% of 2013 market cap).  Higher stock prices create the perception that all is well.


The VIX (measurement of future volatility) is historically low, but reasons for its low level have turned it into a misleading fear gauge.  Fed policy now implicitly provides the market protective puts.  Furthermore, the Fed’s ZIRP (zero interest rate policy) makes investors so starved for any yield enhancement strategies that they are incentivized to sell options (a decaying asset).


The ECB’s LTRO plan (long-term refinancing operations) offered ‘free money’ to banks which was used to buy the higher-yielding debt of their own countries.  The program helped to collapse sovereign debt spreads and create the illusion that all was well in Europe.  (Basel assigns a zero risk weighting to a bank that owns the debt of its own country).

We should know soon which direction the coiling markets intend to breakout. I have offered over the past several weeks a litany of reasons why now is the correct moment (timing) for equities to have a sizable correction (down), and the long end of the Treasury market to break out (lower yields and big curve flattener).   I maintain that viewpoint.  I will not go into those reasons again, but rather offer one new insight.

The strength in the S&P 500 - which is only 1% off of all-time high levels and up 1.7% YTD - may not be as strong below the surface as it appears.  It seems to me that defensive stocks have powered the overall market forward.  Utilities (UTY) and consumer staples (XLP) are breaking out and leading broader averages higher.  These sectors, however, are considered bond-like stocks, so maybe it should be considered a bond (not stock) breakout.  I consider this defensive-type of sector rotation to be a warning signal and an indication of investor desire to de-risk. (After all, QE encourages risk, while the end of QE should do the opposite).

The Three Coupon Treasury Markets

It could be wise to begin thinking of the Treasury curve as three separate markets.  The long end has commodity characteristics.  (In my March 28th note, I outlined the reasoning why there could be supply shortages in long-dated Treasuries due to demand from Corporate Pension plans.)  The front end is driven by changing expectations on the timing and magnitude of future FOMC interest rate increases.  The ‘belly’ of the curve is caught in the crossfire, being pushed and pulled by the wings.