Find three charts enclosed in this piece: the NOB spread (long 30-year bonds/short 10-year notes), June 30-year bonds and finally June 10-year notes. Play your bias with 30-year bonds, as that instrument should move 1.5-3 times the action we see in 10-year notes. That being said if the trade works as planned, traders will make more in the 30-year bond longs than they lose in the 10-year note shorts.
The central bank's bond buying program -- part of the Fed's policies meant to spur the weak U.S. recovery -- have so far yielded profits. But both Fed and IMF economists have said as the economy recovers and interest rates on long-term bonds rise, the massive amount of debt accumulated by the Fed could create losses. Big picture, that could become a political liability as lawmakers start to pressure the Fed on monetary policy. The potential political headache is likely one of the factors central bank policymakers are weighing as they decide whether to continue their extraordinary monetary policy programs. This piece is not meant to debate if the Fed will taper Treasury buying, but rather recognizing an opportunity that after Treasury selling intensified in the month of May, we should experience a relief rally that provides a window for a trade.
Every 1 point move in the NOB spread represents a gain/loss of $1,000. As you can see, we are trading at approximately 12.00 on the spread… the widest the spread has been was 10.50 in mid-March, which is $1,500 of risk. We were trading at 15.50 in the first week of May, which is a $3,500 move from current trade. Using round figures, my objective is a trade back near 14.00, which represents a gain of $2,000 per spread.
If you view this as two individual trades by examining the 30-year bond chart and 10-year note chart, what conclusions can be drawn? Lower trade was rejected yesterday, and it appears we close higher today for the second connective day in both contracts. The stochastics are extremely oversold in 30-year bonds and on a settlement above the 100 day MA (light blue line) next week, we should get confirmation of an interim low. On that, expect a grind back near 147'00 in June futures. As for 10-year notes, we are probing the 100 day MA (light blue line) as of this post. I would expect a trade higher with prices approaching the 50 day MA (red line) in the coming weeks. If I am properly reading the tea leaves, that should be a $3,500 profit in 30-year bonds and loss of $2,000 in 10-year notes for a net profit of $1500 per NOB spread… Good luck and have a safe Memorial Day!
Risk Disclaimer: The opinions contained herein are for general information only and not tailored to any specific investor's needs or investment goals. Any opinions expressed in this article are as of the date indicated. Trading futures, options, and Forex involves substantial risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of future results.