US Treasury Notes Short Trade

A well known philanthropist (John Paul Getty) once said “If you owe the bank $100, that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.”

US Treasury Note Trade

The sooner European politicians read this quote and look in the mirror, the sooner the risk on trade will be back in force. Until then, we could either see their continued failure to accept their lack of responsible lending (and monitoring of recipients), stifling any rallies, or a continuation of the ‘fix the symptoms not the disease’ solutions that may buy them time, but is unlikely to benefit anyone’s retirement funds but their own. Fortunately, 10yr US Treasury Notes are yielding below 2%, from above 3% before June, largely due to their safe haven nature rather than US fundamentals. My view is that the next 6-12 months will be the optimum time to be short US Treasuries, with any entries below 2.1% being favourable, and it’s not because I think high yields will be the result of a European recovery. 


The Reason for Shorting US Treasuries

Considering the global woes, and stock market charts looking eerily similar to the Sep08-March09 formation, it would not be unreasonable to believe that people have been hopefully piling funds back into the S&P as there is little else to hope for. In better times, factors such as ‘coming off a low base’ or ‘short term and unsustainable drop in savings’ could cause good demand figures (manufacturing, consumer or otherwise) to be overlooked, yet the S&P is essentially flat for the year (in comparison with a 20% decline in the Euro Stoxx50). I could crudely liken this to a poker player going all in on a 6 and 7, simply because their last few hands have been a 3 and a 4. The player will, statistically, lose with the strategy, if not this hand then the next, but the other players should be safe and happy in the knowledge that when their time comes, there are other players ready to inflate the stakes at the table and help them to their own win.

This US Treasury Note, SPX and EUR50 disparity is illustrated in the linked chart, with ^TNX representing 10yr US Treasury Note yields:

10 yr T Note yields vs Eur50 vs SPX

So long as investors are willing to get excited prematurely, there will be a floor under yields (1.75% - 1.80% in my view), and whilst the medium term trend may still be bearish for yields (let’s not forget the elephant crossed with Jupiter in the room of US debt levels), there will be ample profit taking opportunities. My view is that any move above 2.4% will see a trailing stop put in place, 15bp behind the 10 day maximum, and until then a fixed stop at 1.75%. Views of the Federal Reserve's zero rates policy seem to vary day to day, but the Jan 25-26 2012 FOMC meeting should be the key date for providing some more colour on their stance. The disparity between investor optimism towards the S&P and US Treasury Notes means I would consider shorting the index in a pairs trade, but most importantly there is a small indicator that there is upside for US Treasury Note yields, regardless of Europe and the US’ fate, in the current investor psychology. For that reason I would recommend the trade be run naked and unhedged. From then on the hope is that either the politicians (and that includes you in the US congress) take a course from an eighth grader in responsibility or that the poker player remains desperate on a 3 and a 4.

Regardless, take pleasure knowing that the average commodity hedge fund return from Jan-Nov 2011 was -3.4%. 

            In the pipeline: Gold stocks vs. gold bullion pairs trade

            Bullish: Gold stocks vs. gold bullion (stocks pricing in lower gold price, profit margins still high)

            Bearish: 10yr US Treasury Notes (underpriced and will see windows for good shorts in the next few months)

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