There are FOUR curve-related topics I want to discuss today:

 

  1. WHITES: A portion of markets are in denial of a Fed hike. It must be that old saying, “fool me once (June) shame on you, fool me twice (Sept) shame on me, fool me thrice (Dec)… %$#@!” Basically it’s the classic tale of the Fed that cried “wolf.”   As a result, there may be more skeptics than usual who believe the Fed won’t hike any time soon.  Liftoff may stay stubbornly underpriced.  There may be value in establishing expiry trades that play for the first two or three hikes.  For now, I am considering various put structures.  After liftoff, there skepticism should abate for future hikes.  So there may be some additional value in playing for the second (and third) hike.

 

  1. GREENS: The year flies centered in the greens were up 6.1bps last week. 3.5 of those bps were on Friday, which is commensurate with stronger economic performance. I don’t have a view on how the “recovery” will continue to progress.  However, I think the road to the terminal FF rate will take longer than expected (rather than shorter).  I like owning flies a little further out that roll up well, rather than trying to guess the location and magnitude of the curvature peak.  Once we think the greens have topped out, we should consider buying slope or curvature structures in the whites vs selling them in the greens.

 

  1. PURPLES: The year flies centered in the back golds and front purples got pummeled for 1.9bps.[1] This was our positioning, but it still has more to go. It remains to be seen if our friend(s) that has been selling purples has given up (or were stopped out) or if this is just a temporary move.  I hope it’s the latter.  As much as I like getting short term P&L, I would much prefer developing a longer-term source of income.

 

  1. BEAR FLATTENING. We should see bear flattening in the short term – especially while the 30 year down-trend line in ten year yields is intact. There are many senior traders who have made a career out of just being long the long end at opportune times.  It doesn’t look like the trend line is going to break this year.  I’m not sure where the momentum would come from – I’m on board for a few hikes, but it’s not because I’m convinced of economic strength.  The Fed just wants to remove a small amount of the excess accommodation before the oil price declines fall out of the yoy inflation calculation.  Also, treasuries are already cheap to swaps.  The key thing about bear flattening is that curvature in the “belly” will get higher, as curvature further out will get lower.  So I still like being long the negative year double flies.

 

[1] This is a large move for flies this far out.