Tuesday, November 21, 2017

TUZ; 2 Year Treasury - Setting the Pace

The 2yr Treasury future (TUZ7) has seen a fairly dramatic decline since reaching a multi-month high on September 8.  Since then generic 2yr Treasury yields have jumped 50 bps. from 1.26% to 1.76% as yields marked territory not seen since late 2008. 

If some trend lines were to be drawn, we would see that the modestly rising yield since mid-2013, then a mere 20 bps., held to a momentum of roughly 25 bps per year until October of this year, when the yield spiked through that trend.  


 As abrupt as the advancing yield looks on the multi-year chart, the futures price action since mid-September shows a much more graduated decline.  The fall from September 8th to the mid-Sep low (Sep 20 @ 107-27.75) was rather dramatic, but since then, declining prices have been consistent but temperate.

A trend line I am using on the futures chart shows the pace of decline now potentially accelerating.  TUZ7 is testing the lower extreme of the channel that could be drawn since September 20th to mark the pace of decline.  A settlement through the lower trend line of this channel might suggest greater attention paid as the consequences could be a further spike in yields.  At the same time, a ‘failed break’ could mean a sharp reversal. 


We favor one form of trend analysis which gives indication of trend vulnerability as result of its consistency.  TUZ7 has achieved 12 new daily session lows since late-October without a three session pause.  As much as we appreciate trends, finding situations where a trend is stretched gives us clues to potential momentum shifts, either accelerated or reversed.  We are at that stage now and are particularly mindful of this potential.

Economic data has shown continued employment gains and lagging inflation indicators.  Production and sentiment data have improved recently and the pace of economic growth in Q4 is expected to be well above perceived potential output.  The Treasury yield curve has flattened considerably since the beginning of the year.  The Treasury 2’s-10 yield spread at 60 bps has not been seen since late-2007.  This indicates a belief that the Fed is expected to raise policy rates to thwart potential inflation induced by tight labor and product markets as well as ‘bubbly’ asset markets.  At the same time, the declining yield spread, to some, suggests a potential recession and Fed overshoot in the coming years.  


In any event, the push through a multi-year, rising cash yield momentum as well as the test of a multi-month, ‘stretched’ futures bearish trend is reason to more vigilantly follow developments.