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10y Treasury Futures On Coming Rate Hikes March 2017

market's have priced in almost 100% certainty of a rate hike, after a very strong Non-Farm payroll today.

USD 2y yield at 1.366% as of now, with 10y now at 2.55% (10y June futures at 123.00).

I plot the 3-yr history of the market-data to see if there are any relative value trades that might be possible.

The first graph shows the 10y real-rate (10y yield - 10y breakeven inflation), and the 10y break-even. Expected 10y inflation is now highest (at around 2%) since 2015, though pre-crisis inflation was running at around 2.5%.

We see real-rate ranged between zero and 80bp, with medium of around 45bp. Currently, real-rate is 50bp, meaning we could see around 50% of increased real-rates.

We plot the scatterplot of 10y real-rate against the 10y inflation (back to 2015). Currently, at 2.0%, and 50bp for real-rate, we observe that

1. for 10y yield to increase requires 10y break-even to be above 175bp in general (assumption), as well as real-rates to be above 50bp.

2. Looking at the population at data-points, we observe that there is only a small population as such.

Hence, data-plot of back to March 2015 suggests there is little upside risk of further spikes in 10y treasury yields of above 2.5%. However, this should not be borne out if the Fed hikes more than 3 times (Hawkish tones), bringing the front-end (2y) > 1.75% and there is sustained high inflation print of >2.5% (causing the markets to predict a long-term CPI of 2.5%).

Given the Fed's (at least stated) goal of keeping inflation stable at around 2%, a sustained high inflation print will conversely force aggressive short-term hiking. Short-term high rates will actually help to reduce long(er) term yields (read 10y and above) as markets expect future inflation to be contained.

For the traders willing to wait, a LONG position in 10y treasury futures, against a SHORT 10y breakeven position, can be entered when yields hit 2.70%, with 10y break-even at 0.80% and above.

Supporting Documents

  1. 10y_yield_chart_scatterplot.jpg
  2. 10y_yield_chart.jpg

Disclosure: I am/we are long US 10Y BOND FUTURES.