Curve Watchers Anonymous noted an interesting thing on Friday and again today. The long end of the yield curve is rallying or steady (yields declining), while the middle portion of the curve is selling off (yields rising).
This happened on Friday and again today.
Yield Curve as of Friday’s Close (2009-12-11)
Yield Curve as of Monday (2009-12-14 15:21 EST)
On Friday, the 2-year, 3-year, 5-year and 7-year yields rose, with the 5-year and 7-year yields rising more than the 10-year yield. The long bond yield dropped.
Today, the long bond (30-year) treasury yield is lower again, with the 10-year yield flat, while the 2-year, 3-year and 5-year yields are rising.
This is not normal action to say the least.
On December 11, in Yield Curve Steepest Since 1980; Hard Times Ahead in 2010 I stated “Judging from action in the 5-year treasury, it appears as if there is a long 3-to-5 year, short 30-year trade in play.“
Here is a chart I made last Thursday, and posted Friday.
Yield Curve As Of December 10 2009
Flashback July 16, 2009: Pimco Says Improving Economy to Steepen Yield Curve
The difference between Treasury two- and 10-year yields may widen to record levels set last month as the U.S. economy recovers, according to Pacific Investment Management Co., which runs the world’s biggest bond fund.
“Long-term rates will rise at a faster speed than short- term rates,” Pimco portfolio manager Tony Crescenzi wrote in a report distributed by e-mail early in the Asian trading day. “Market participants decided months ago that the Armageddon scenario was out and stabilization was in,” he said.
The so-called yield curve steepened to as much as 2.62 percentage points today, the most in almost four weeks. It rose to a record 2.82 percentage points on June 5 as investors demanded greater compensation for the risk that growth will spark inflation. Just a week ago, investors said the curve would narrow on signs the global economic recovery was petering out.
Clearly that was a good play and I congratulate PIMCO.
Should the pattern from today and last Friday continue, it would be a reversal of a long 3-to-5 year, short 30-year trade in play.
Certainly, there is little value in 2-year yields at .85% or 3-year yields at 1.35%.
I am now wondering if PIMCO (or someone) is unwinding a yield curve steepening trade.
My friend “HB” writes:
I think there are some trading programs out there that are playing ‘reversion to the mean’ trades. In fact, I know of one fund that is specializing in almost exclusively trading the 2/10 spread.
It uses a proprietary systematic approach (i.e. a quant method, run by computer algorithm), and while they didn’t divulge the details of course, I could see from the trades they put on that some of it is based on reversion to the mean.
So when the curve reaches a new extreme widening as has recently happened, you will see some of these specialized and macro credit funds step in and put on flattening trades.
Mike “Mish” Shedlock
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