Tuesday, October 20, 2015

Treasury Traders Get Soft In The Belly Of The Curve

The Treasury yield curve between 2 and 5 years out flattened by an incredible 37 basis points since mid-July (from 104 to 67 bps).  Now that process may be reversing.  The belly of the curve has attracted a lot of bullish participation as traders were increasingly concerned with the prospects for China selling off its Treasury holdings while at the same time fearful that the economy was stalling out. 

This left traders increasingly interested in holding Treasury securities that were shorter in duration than longer-term bonds, but longer than 1-year bills or 2-year notes.  The belly of the Treasury curve may not be as safe a harbor as some five year Treasury note buyers had grown accustom.  One trader voted with his feet this morning and sold nearly 20,000 five year Treasury note futures. 

We might expect additional sales as it appears that traders have wrongly become generally too comfortable in the notion that the Fed will find excuses for delaying any removal of accommodation this year even if the economic data suggests they do so. 

When we look at the CFTC commitment of traders report detailing the bullish participation by ‘non-commercial’ accounts, the level of longs does not itself argue strongly for continued bullish trade.  Instead, it suggests at best lackluster and ‘residual’ bullish interest. 

Technically too, the price action is starting to falter.  The bullish advance following a disappointing September employment report has not been verified with additional gains.  Instead, the market has backed off, with one decent attempt at the recent high summarily rejected.  In candlestick terms, the bearish price action of that recovery attempt on October 14-15 in the five year Treasury future was a ‘bearish dark cloud cover’.  Price action today appears ready to make a bearish engulfing of yesterday’s somewhat indecisive session. 

Bottom line: unless there is a surprise and substantial bullish recovery today, we expect there will be further treasury losses over the coming sessions and quite possibly substantial between today and the next employment report on November 6th.  At the front end of the curve, bullish participants have been somewhat lazy and they are expected to receive a wake-up call with a re-pricing of EDZ5 that would come from the pricing of a better than 30% chance for a December FOMC rate move.  Otherwise, the belly of the curve could take it hard on the chin as it has been the ‘go-to’ for modestly bullish management.  Of course, the Treasury long end is not immune to higher rates, but the yield curve between 5’s-30’s is expected to flatten somewhat from the current level of 154 bps.    



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