On June 12th this article was published on the TLT / FXE spread. The article suggested a number of ways to play a decline in the TLT / FXE spread. We will discuss and review the underlying issues [TLT & FXE]. The premise was that the spread may decline and to be short TLT and long FXE.
Let's see what has happened to the underlying issues to date.
- 125.55 June 12
- 127.08 June 18
- (1.53) Loss
- 124.16 June 12
- 125.09 June 18
- 0.93 Gain
(0.60) Net Change of Spread
Here is a chart of the theoretical high-low spread since June 11th. The red bar is the closing spread value. The high spread value is the TLT high less the FXE low for the day. The low spread value is the TLT low less the FXE high for the day.
Both the TLT and FXE have increased in value since June 12th. The spread has reduced the risk of the loss. It is somewhat surprising that the TLT has increased in value, or that interest rates have declined. It has been expected that interest rates will move higher. Not a great deal higher, but the prospect of lower interest rates seem misplaced unless one is in the recession / depression / deflation camp. Of course I could be wrong. Time will tell.
It is tough to figure out what might happen to the Euro or where it should trade. Should the Euro-zone break-up then how will contracts be settled? If a party contracted to be paid in Euro's but there isn't a Euro, do they get paid with something else or nothing? What if all members of the Euro-zone returned to its former currency. This might be good news for the CME, as old future contracts might be dusted off allowing for greater trading volume. Though the cost of hedging and monitoring the position may increase. It might be a nightmare for world economies if the Euro were to disappear. The teachers union saved New York City from bankruptcy in the 1970's. Will a group(s) emerge to save the Euro? Might economic growth slowly rebound increasing government revenue making debt service less of a burden. Or might an asset backed bond, say a gold-backed bond help calm market fears? The weekend election in Greece did not result in much movement.
The risk in the long FXE / short TLT spread is that the Euro [FXE] declines and US interest rates continue to fall [TLT increases]. Given the more recent market conditions anything is possible. However the longer-term TLT/FXE chart suggest the spread might be near its upper limit.
Initial target for the spread would be minus 10.00 points, which was last seen on May 10th.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.