Image placeholder title

Bloomberg calls this setup a "Fed-Proof" Bond Bet.

Whether President Donald Trump nominates Fed Board Governor Jerome Powell, Stanford University economist John Taylor or even current Chair Janet Yellen to lead the central bank, one trade is foolproof in the eyes of many on Wall Street: betting on a flatter U.S. yield curve. By most measures, the spread between short- and long-term Treasuries is already the slimmest in a decade as the Fed raises rates in the face of tame inflation.

“If they’re going to continue on this normalization path -- and whoever comes in is going to do that -- you’re just going to continue to see this flattening yield curve,” said Eric Souza, senior portfolio manager at SVB Asset Management.

The surging two-year yield, in particular, highlights how much traders have had to alter expectations for the Fed, which in 2016 projected four rate hikes but only moved once.

The markets are coming around to the Fed’s projected rate path for 2017. The implied odds that the central bank will boost rates by year-end have jumped to about 82 percent, from 65 percent at the start of the month, based on overnight index swaps and the effective fed funds rate.

Those expectations are also showing up in the futures markets. Hedge funds and other large speculators extended net-short positions on both two- and five-year Treasury futures to a record last week, according to Commodity Futures Trading Commission data through Oct. 17.

John R. Taylor, former head of the world’s biggest currency hedge fund, said last week that his analysis of statistical patterns indicates the curve flattening is done.

For now, though, it’s going to be tough for the 10-year yield to exceed 2.4 percent, a key technical level for months, said Justin Lederer, an interest-rate strategist at Cantor Fitzgerald. The yield twice flirted with that mark in October, only to retreat.

Flattening

I did not think the Fed would get in another hike this year. However, the move to replace Yellen with an alleged hawk has the market convinced. The Fed is highly unlikely to disappoint.

RECOMMENDED ARTICLES

Then what?

Hurricanes have made it harder to assess the true state of the economy. Notably, there has been an inventory build to replace damaged autos. Some blame the hurricanes for housing weakness.

But housing has been slowing for six months, autos even longer. This is not a robust economy.

These "sure thing" bets are typically a contrarian indicator.

I stick with my assessment the next big move in yields is lower, not higher. Hedge funds plowing into a "sure thing" bet that 5-year yields are headed up may come to regret that decision.

Mike "Mish" Shedlock

Fed Still Struggles to Get a Grip on the Bond Market

Bond market volatility remains a sight to behold, even at the low end of the curve.

Speculative Bond Short Hits New High: Others Claim "Rates Headed to Zero"

Iflationistas think a major inflationary move is at hand and they bet that with futures. I suggest the opposite.

Currency Wars: Greek 10-Year Bond Yield Dips Below 2% as Bets on Rate Cuts Rise

For the first time ever, Greek 10-year bond yields dipped below 2%.

"You Bet Your Heinie" Bill Gross Needs a Fatter Crayon

David Tepper is short bonds. Bill Gross says the treasury bull market is over. Hoisington Management Strongly Disagrees.

Treasury Yields Surge: Crowded Bet a Winner for Now

Treasury yields are up across the board, with the 30-year bond approaching a breakout level.

Yellen Wants Fed to Commit to Future Booms to Make Up for Busts

Former Fed Chair Yellen promotes "Lower for Longer", a policy in which the Fed knowingly keeps interest rates too low.

Faith in Central Banks Again in Question: Ominous Implications for Bonds

All eyes are following implications of a yield curve inversion. A crucial portion of the curve signals something else.

Fed Does Another Emergency Repo and Relaunches Commercial Paper Facility

The Fed keeps trying things hoping that something will stick.

Historic Crash in Bond Yields and More Coming

Bonds yields crashed this week. The Fed made emergency inter-meeting cuts last week but that is just the start.