Playing in the Treasury Bond Auction Pool

As macro traders it behooves us to examine the stellar 2 year note auction. The bid to cover was 3.19 and indirect bidders took 68.6% of the auction!! Anyone who thinks foreign central banks have stopped buying U.S. debt should look to this auction for clarity.

Click to enlarge:

2 Year US Note Future – Sep 09 – 60 Minute Chart

Prior to the auction the 2 year was strong and accelerated after the announcement. Now let’s go out a few years on the curve because Wednesday the Treasury auctioned 5 year notes.

Click to enlarge:

5 Year US Note Future – Sep 09 – 60 Minute Chart

Interestingly the 5 year note did not participate in the bond market euphoria on Tuesday. The likely explanation is risk aversion ahead of Wednesday’s auction. However, the muted action in the 5 year leaves the yield curve distorted in the short term. If today’s auction is at least in line with prior auctions the 5 year will have to play catch up. We intend to play this potential slingshot through the iShares 3-7 Year Treasury ETF (IEI). This ETF has an average maturity of 4.86 years and is designed to track the 5 year note.

Click to enlarge:

30 Year T-Bond Future – Sep 09 – 60 Minute Chart

We purchased the iShares 20+ Year Treasury ETF (TLT) on the strong 2 year auction. The 2 year note is the maturity of choice for investors to hide from inflation. The strength in this maturity suggests that investors no longer are concerned about inflation. Since the long end of the curve involves maturity risk this sector tends to be more volatile and is the reason we chose to purchase TLT.

Click to enlarge:

Additionally, since the mid-month inflation “scare” the break even inflation rate (BEI) has declined below 2%. As a component of bond yields, falling inflation means lower yields and higher prices.

Disclosure: I am long TLT, IEI and call options on IEI

Comments

[Gerry Sullivan:]

That was a good call. A specific recommendation based on well thought out analysis.

Jun 26 12:21 PM