TLT Over FXE Spread July Update

Includes: FXE, TLT
by: Pat Stout

I have been 100% wrong on the direction of the TLT - FXE spread. The fear bid in US Treasuries has sent the price of the TLT surging higher while the value of the Euro turned lower. This was not expected. In hindsight the gap lower in late June that quickly reversed should have been sign the trend might have changed.

In the original article three ways to play decline in the TLT less FXE spread were mentioned.

The spread is at record levels for my data. See chart below.

On December 21, 2005 the FXE closed at $118.45 and the TLT closed at $90.52. The Euro per bond (TLT/FXE) was 76.42.

On July 20, 2012 the FXE closed at 120.91 and the TLT closed at 130.06. The Euro per bond (TLT/FXE) was 107.57.

On July 24, 2012 the FXE closed at 120.02 and the TLT closed at 131.75. The Euro per bond (TLT/FXE) was 109.77.

The Euro is little changed from December 2005 while the TLT has surged in value. It has become more expensive to purchase the TLT in Euro terms.

Tough to say where the spread goes from here, it has not acted as expected.

This was said in the original article.

Time will tell if longer-term U.S. Treasury issues continue to outperform the euro currency. The valuation appears to be nearing its limits. However, if the euro sank to par with the dollar and the TLT was flat then the spread could increase to nearly 30, (original article had 130, a typo). If the TLT increased in price then the spread could increase even more.

Given that the spread traded at a -68.55 valuation, going to a +68.55 valuation might be possible, but is it probable? And if it happened what would it mean good or bad times for the world and U.S. economy? It might signal tough economic times for all.

If the fear bid remains in US Treasuries, the Euro continues to weaken combined with economic worries. Then it might be possible to see the trend continue with the spread hitting 30 or more.

If America returns to the land of risk takers then interest rates might move slightly higher resulting in a flattening of the spread or it turning lower depending upon the action of the Euro.

However, judging from the recent action in the bond market investors are fearful and content owning Treasuries at any price. And a stronger Dollar (weaker Euro) may assist Europe in growing its economy by making its goods and services cheaper in dollar terms.

The idea of the spread was to reduce risk, unfortunately both sides of the spread have moved in the wrong direction. It clearly didn't work as expected.

I expect interest rates to be flat or move higher and the Euro to be flat or move higher. Therefore the outlook for the spread is for it to narrow. My original outlook remains in place.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.