TLT-FXE Spread Update With Thoughts On The Federal Reserve

Includes: FXE, TLT
by: Pat Stout

June 20, 2012 saw sharp moves in the TLT and FXE with the release of Federal Reserve FOMC statement and the statement regarding the continuation of the maturity extension program. The most interesting part of the statement was that the Federal Reserve holdings of securities maturing before January 2016 would be minimal. Therefore the Federal Reserve might be allowing short-term (0-3 year) issues to move higher in yield with the hopes of flattening the yield curve.

Bonds rallied (interest rates fell) and the Euro declined (dollar rallied) right after the FOMC statement; then they reversed course. Notice the length of the daily bar for the spread, (see chart below). It would appear headlines are moving the market.

Inaction by Congress might be putting the Federal Reserve in a difficult position. The conventional wisdom appears to be that a lame-duck Congress will address the so-called "fiscal cliff". However, elections have a way of throwing a money wrench into conventional thinking. What if the House, Senate and or the White House change hands? Might departing representatives be in no mood to make decisions for the newly elected representative? By waiting, Congress is making economic growth more of a challenge, aren't they? Members of the FOMC have downgraded the economic outlook. Let us hope that Congress will find a way to help restore some trust in the marketplace and do it before they go on an extended summer vacation.

Would the economy and business gain certainty, and or confidence, should the Supreme Court decided to delay its decision on the Patient Protection and Affordable Care Act until after the election? Or might that create more economic headwinds? If Congress may kick the can down the road to avoid making tough decisions in an election year, then shouldn't the Supreme Court have the same option?

Here is a chart of the TLT less FXE 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.

Let's see what has happened to the underlying issues to date.

TLT [Short]

  • 125.55 June 12
  • 127.08 June 18
  • 126.04 June 20

FXE [Long]

  • 124.16 June 12
  • 125.09 June 18
  • 126.13 June 20

TLT less FXE Spread Values

  • 1.39 Spread Value June 12
  • 1.99 Spread Value June 18
  • (0.09) Spread Value June 20

The spread in moving the right direction. The initial target for the TLT less FXE spread was minus 10.00 points, which was last seen on May 10th. The short TLT and long FXE spread target would be the inverse, or a plus 10.00 spread.

The risk in the long FXE/short TLT spread is that the Euro declines and US interest rates continue to fall. Given the more recent market conditions, anything is possible; however, the longer-term chart suggest the spread may reverse. The events of today did nothing to change my opinion.

Both the TLT and FXE have increased in value since June 12th. The spread has reduced the risk of the position. The TLT and FXE had wide trading ranges today (June 20th) in reaction to news, discussed below.

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.

Prior TLT / FXE spread articles:

June 12th article

Ways to play a decline in the TLT less FXE spread:

  • Short TLT (currently 125.55) and go long FXE (currently 124.16).

Or use options. The September 2012 series may provide adequate time.

  • Long FXE 126 Call @ 2.42 and Long TLT 124 Put at 5.45.
  • Or buy the 126 call 124 put straddle on FXE (roughly 5.80) and TLT (roughly 10.00).

Follow-up June 18th article

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.


Remain with the long FXE / short TLT trade. It has been working.

Source data: Yahoo Finance

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