The US Term Structure - A Saga

We recommended Oct/11 that clients own (L-S) the US curve, with a reminder on Oct/13 that nothing had changed, to remain or get long, especially 2-30, despite that day’s very successful 30yr auction.

We try to keep things simple with our spreading activity. We had been watching the curve; it had come in some given disappointing real sector results, and, moderate quality flight tagged to E-Z worries. Our trigger was that we expected real sector results to exceed expectations in the near term. Next, we thought the recent operation “Twist” by the Fed, past a few days, would have the reverse impact desired. The E-Z presented the major threat to the trade as we had no idea what these types would be up to next.  But even given that, we thought the spread was narrow enough to weather most of it - that is, it had a contained down side and a substantial up side.

The strategy performed satisfactorily early on, expanding so that by Oct/27, 5-10 was better by 14 bps, 2-10 better by 12 and 2-30 by 37.  To be expected, given that we had an E-Z “deal” that day, and, given that recent data had cooperated. That is, absent world panic, fundamentals worked to expand the curve.

Then however, intensified E-Z worries impacted the spread; the panic on Oct/31 brought the wider trades in considerably, 5-10 less so. At the close Oct/31, 2-30 was 290 vs 313, Oct/27.  Further panic Nov/1 brought 2-30 in to 281; 2-10, to 178 vs 200, Oct/27.  By Nov/18 we were at entry level on 2-30, 13 better on 5-10 but 15 worse, 2-10; and again, even though US releases had cooperated.

Recently the spread expanded modestly, on better-than-expected US results and diminished quality flight. But at the close today we are narrower on the Fed’s report, on renewed E-Z concern and on the growing view that Q4 real sector improvement may have topped out.

Thus, we are not as enthused as we were in early October. Course of least resistance for this spread is to remain wider and we want to look for chances to own, not to sell it but we don’t expect a heck of a lot of progress over the near term. For those looking to enter this trade, concentrate on 5-10, the most reliable performer, the least likely to be stricken by world panic.


Robert Craven