Big futures trade adds to steepening momentum amid selloff.
(Bloomberg) — Traders in the $14.1 trillion Treasuries market are signaling that the persistent flattening of the yield curve this year has gone far enough.
The outperformance of longer-maturity debt has been a dominant theme in the market for months. Now, open interest data show investors are unwinding wagers that the slope of the yield curve from five to 30 years will fall, after it turned the flattest in nearly a decade.
In one case, a trader executed large block trades in 10-year and ultra-long futures. The combination created a bet on curve steepening that gains or loses $4.2 million for each basis point move in the yield spread. It’s already up more than $10 million, extending gains after Treasury’s $28 billion seven-year auction drew a yield that was below indications from before the sale.
The futures positioning reflects a sentiment shift in Treasuries as traders gain conviction that the Federal Reserve will tighten again in December and as President Donald Trump promotes his tax plan. The benchmark 10-year yield, at 2.31 percent, broke above its 200-day moving average for the first time since August.
“Selling blocks have weighed on long duration Treasury notes” as traders adjust expectations for a tax overhaul, John Herrmann, director of U.S. rate strategy at MUFG Securities Americas, wrote in a note Thursday. At the same time, shorter maturities “are barely pricing in any FOMC interest rate action beyond the December” meeting, leading the curve to steepen.
To be sure, the benchmark is right around its 2017 average, a long way from the 3 percent level that some analysts predicted to start the year. And the curve is still within spitting distance of pre-financial crisis lows. But the pullback highlights that traders may have gotten too aggressive in wagering long-term yields couldn’t move higher.
At the very least, it shows investors are wary of a repeat of the events of right around this time last year, when 10-year yields rose 75 basis points in seven weeks. Money managers in Japan, where the fiscal half-year closes Sept. 30, were hit particularly hard.
Treasuries tumbled in Asia trading hours Thursday, with some traders saying Japanese investors are stepping back. The selling momentum intensified after the 10-year yield rose above its 200-day moving average, spurred in part by hedging with options against even-higher interest rates.
And investors aren’t just turning bearish on long-term rates. Traders are alsoadding to wagers on declining eurodollar futures, positions that profit if the market prices in more Fed hikes. The odds that policy makers boost rates again in December are about 66.6 percent, based on overnight index swaps and the effective fed funds rate. A full rate hike isn’t priced in until mid-2018.
So while Treasuries aren’t in a bear market just yet, the bullish momentum that pushed long-bond yields to the lowest since November has certainly faded.
In other words, the hope that President Trump could undo Obama-era legislation (amongst other things) has faded to near zero.
So now we are in a Game of Thrones world where the 10 year Treasury yield has to rise faster that the 2 year yield to get the curve climbing again.