April 17th, 2014 10:49 am | by John Jansen |

The yield curve is power flattening again today after a very brief overnight steepening interlude. The 5s 30s spread is at 177.6 basis points a few minutes ago when I marked it. When I marked prices at 555AM the spread was 181.2 basis points and yesterday at 600AM the spread was just north of 185. Similarly, 10s 30s is inside of 80 at 79.9 after opening at 81.6. That level and the 5s 30s level are each cycle lows.

What is going on here? This morning I cited bad positions being sent to the dustbin. That in a sense is the last refuge of a salesman who doesnt know the answer and is scrambling for a plausible explanation when he does not have one.

I spoke with two long end traders and each buys that explanation for the local trade but not for the fundamental shift in the curve. Each believes that the likely explanation lies with end user retail and that there is probably a large well known client who had a giant underweight in the long end and a massive overweight in the belly. Those trades are being unwound (the reasoning goes) and it will be very difficult to have an appreciable steepening until that process finishes. So all of the off the run 5s 7s and 10s which were the heart of the buy and hold and carry trade are being obliterated against the Long Bond.

One of the traders with whom I spoke also mentioned the story I sent out this morning on the shift in allocation by a large Japanese pension fund. Some of the proceeds he reasoned would end up in foreign bond markets and the one market in which can grab huge chunks of liquidity quickly is the US. He thought that flow when it happens would also benefit the long end of the US.

Finally there is a flow I wrote about earlier this year and that is the ongoing process in which funds place new moneys into fixed income. Last year was a banner year for equities and consequently some asset managers are placing new money into bonds rather than equities and than ongoing process has richened bonds and capped out corporate spreads and kept those credit s[reads at seemingly stupid levels.

So yes there are local trades in which traders have been stopped out but the underlying fundamental driving the curve shift is a reallocation trade by end user retail.

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  1. 2 Responses to “Curvology”

  2. By Mike C. on Apr 17, 2014 | Reply

    Interesting forces are at work in the capital markets for sure.

  3. By Mike C. on Apr 17, 2014 | Reply

    Don’t buy the move into the long end because it was cheap – it wasn’t. It was ‘less over priced’.

    Are we overthinking this? Perhaps the market is just pricing in the peak of the cycle here over the next 6 months.

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