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12-23-2013, 02:09 AM
The big yield curve steepener unwind
By Sober Look (http://soberlook.com/)
Since the Fed an**unced the reduction in securities purchases (“small taper” (http://soberlook.com/2013/12/inflation-measures-point-to-bullards.html)), the treasury curve has undergone some strange adjustments. Here is what the impact has been since the close on December 17th. Why would the 5-year **te sell off the most while the long bond rallied?
http://3.bp.blogspot.com/-57qfN8SMigo/UrYdDru1BeI/AAAAAAAAdUo/WB3JIz1oHBc/s1600/Taper+impact+on+treasury+curve.PNG (http://3.bp.blogspot.com/-57qfN8SMigo/UrYdDru1BeI/AAAAAAAAdUo/WB3JIz1oHBc/s1600/Taper+impact+on+treasury+curve.PNG)
The answer has to do with how the market was positioning prior to this event. Many traders had two expectations:
Taper is coming next year and the impact should raise long-term rates
The Fed will keep short term rates near zero for a long time
The trade that takes advantage of this view is the so-called “steepener” trade – long short-term treasuries and short long-term treasuries. And that’s how the market was positioned going into the an**uncement. But a combination of the “early” taper, stronger than expected eco**mic data (below), and a less than stellar 5-year **te auction made some question the #2 assumption above.
http://3.bp.blogspot.com/-P-bQVvFGwKw/UrYmqALUrFI/AAAAAAAAdU4/nhiDBv2oS20/s1600/Housing+starts+and+GDP.PNG (http://3.bp.blogspot.com/-P-bQVvFGwKw/UrYmqALUrFI/AAAAAAAAdU4/nhiDBv2oS20/s1600/Housing+starts+and+GDP.PNG)Source: Investing.com After what we’ve seen over the past five years it is difficult to imagine this scenario, but what if the US eco**my unexpectedly accelerates? The Fed will be forced to begin pushing short-term rates up faster than originally expected. The market started to price in a higher probability of just such an event. As an illustration, take a look at the June-2015 fed funds futures contract. The steepener trade had*pushed the first rate hike expectations further out in time (higher futures price = lower expected fed funds rate). But the an**uncement, combined with improved eco**mic data, forced a selloff in the contract – with the market **w expecting the first hike by the middle of 2015.
*
http://1.bp.blogspot.com/-8ST-c0FBitw/UrYw4pTHkGI/AAAAAAAAdVU/MSwFmCZpA5E/s1600/Fed+Funds+Futures.png (http://1.bp.blogspot.com/-8ST-c0FBitw/UrYw4pTHkGI/AAAAAAAAdVU/MSwFmCZpA5E/s1600/Fed+Funds+Futures.png)
This earlier-rate-hike scenario impacts shorter-term treasuries more than it does longer-dated **tes/bonds. The adjustment in expectations forced an unwind of the steepener trade, creating the “flattening” move in the yield curve we see in the first chart above. Anecdotal evidence suggests that this unwind ended up being quite painful for a number of market participants who had piled into the trade.
More About: Eco**my (http://www.creditwritedowns.com/tag/eco**my/), Federal Reserve (http://www.creditwritedowns.com/tag/federal-reserve/), interest rates (http://www.creditwritedowns.com/tag/interest-rates/), Markets (http://www.creditwritedowns.com/category/markets/), monetary policy (http://www.creditwritedowns.com/tag/monetary-policy/), prediction (http://www.creditwritedowns.com/tag/prediction/), quantitative easing (http://www.creditwritedowns.com/tag/quantitative-easing/), United States (http://www.creditwritedowns.com/tag/united-states/)
The most in-depth research and analysis is on Credit Writedowns Pro (https://www.creditwritedowns.com/members/).
The big yield curve steepener unwind (http://www.creditwritedowns.com/2013/12/the-big-yield-curve-steepener-unwind.html) originally appeared on Credit Writedowns (http://www.creditwritedowns.com)
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Related posts:
China’s short-term rates have stabilized but the yield curve remains inverted (http://www.creditwritedowns.com/2013/07/china-liquidity-stabilize-yield-curve-inversion.html)
The Fed exerts a dominant influence across the yield curve, **t just on the short end (http://www.creditwritedowns.com/2013/03/the-fed-exerts-a-dominant-influence-across-the-yield-curve-**t-just-on-the-short-end.html)
As yield curve steepens, banks outperform (http://www.creditwritedowns.com/2013/12/as-yield-curve-steepens-banks-outperform.html)
By Sober Look (http://soberlook.com/)
Since the Fed an**unced the reduction in securities purchases (“small taper” (http://soberlook.com/2013/12/inflation-measures-point-to-bullards.html)), the treasury curve has undergone some strange adjustments. Here is what the impact has been since the close on December 17th. Why would the 5-year **te sell off the most while the long bond rallied?
http://3.bp.blogspot.com/-57qfN8SMigo/UrYdDru1BeI/AAAAAAAAdUo/WB3JIz1oHBc/s1600/Taper+impact+on+treasury+curve.PNG (http://3.bp.blogspot.com/-57qfN8SMigo/UrYdDru1BeI/AAAAAAAAdUo/WB3JIz1oHBc/s1600/Taper+impact+on+treasury+curve.PNG)
The answer has to do with how the market was positioning prior to this event. Many traders had two expectations:
Taper is coming next year and the impact should raise long-term rates
The Fed will keep short term rates near zero for a long time
The trade that takes advantage of this view is the so-called “steepener” trade – long short-term treasuries and short long-term treasuries. And that’s how the market was positioned going into the an**uncement. But a combination of the “early” taper, stronger than expected eco**mic data (below), and a less than stellar 5-year **te auction made some question the #2 assumption above.
http://3.bp.blogspot.com/-P-bQVvFGwKw/UrYmqALUrFI/AAAAAAAAdU4/nhiDBv2oS20/s1600/Housing+starts+and+GDP.PNG (http://3.bp.blogspot.com/-P-bQVvFGwKw/UrYmqALUrFI/AAAAAAAAdU4/nhiDBv2oS20/s1600/Housing+starts+and+GDP.PNG)Source: Investing.com After what we’ve seen over the past five years it is difficult to imagine this scenario, but what if the US eco**my unexpectedly accelerates? The Fed will be forced to begin pushing short-term rates up faster than originally expected. The market started to price in a higher probability of just such an event. As an illustration, take a look at the June-2015 fed funds futures contract. The steepener trade had*pushed the first rate hike expectations further out in time (higher futures price = lower expected fed funds rate). But the an**uncement, combined with improved eco**mic data, forced a selloff in the contract – with the market **w expecting the first hike by the middle of 2015.
*
http://1.bp.blogspot.com/-8ST-c0FBitw/UrYw4pTHkGI/AAAAAAAAdVU/MSwFmCZpA5E/s1600/Fed+Funds+Futures.png (http://1.bp.blogspot.com/-8ST-c0FBitw/UrYw4pTHkGI/AAAAAAAAdVU/MSwFmCZpA5E/s1600/Fed+Funds+Futures.png)
This earlier-rate-hike scenario impacts shorter-term treasuries more than it does longer-dated **tes/bonds. The adjustment in expectations forced an unwind of the steepener trade, creating the “flattening” move in the yield curve we see in the first chart above. Anecdotal evidence suggests that this unwind ended up being quite painful for a number of market participants who had piled into the trade.
More About: Eco**my (http://www.creditwritedowns.com/tag/eco**my/), Federal Reserve (http://www.creditwritedowns.com/tag/federal-reserve/), interest rates (http://www.creditwritedowns.com/tag/interest-rates/), Markets (http://www.creditwritedowns.com/category/markets/), monetary policy (http://www.creditwritedowns.com/tag/monetary-policy/), prediction (http://www.creditwritedowns.com/tag/prediction/), quantitative easing (http://www.creditwritedowns.com/tag/quantitative-easing/), United States (http://www.creditwritedowns.com/tag/united-states/)
The most in-depth research and analysis is on Credit Writedowns Pro (https://www.creditwritedowns.com/members/).
The big yield curve steepener unwind (http://www.creditwritedowns.com/2013/12/the-big-yield-curve-steepener-unwind.html) originally appeared on Credit Writedowns (http://www.creditwritedowns.com)
Links: RSS (https://www.creditwritedowns.com/feed) - Daily (http://eepurl.com/hfF3U) - Weekly (http://eepurl.com/eklTA) - Twitter (http://twitter.com/edwardnh) - Facebook (http://www.facebook.com/creditwritedowns) - Contact (https://www.creditwritedowns.com/contact)
Credit Writedowns Feed # abf0d081857b85fe6be494728740a4f1
Related posts:
China’s short-term rates have stabilized but the yield curve remains inverted (http://www.creditwritedowns.com/2013/07/china-liquidity-stabilize-yield-curve-inversion.html)
The Fed exerts a dominant influence across the yield curve, **t just on the short end (http://www.creditwritedowns.com/2013/03/the-fed-exerts-a-dominant-influence-across-the-yield-curve-**t-just-on-the-short-end.html)
As yield curve steepens, banks outperform (http://www.creditwritedowns.com/2013/12/as-yield-curve-steepens-banks-outperform.html)