I am starting to get used to posting the 6mo spread graph as a way to express my views. The thing that amazes me is how frequently we keep managing to stay within the 2bp green box. This was not the case at the height of the post-Brext 34bp explosion, where the green box was 7.5bps wide. Yikes! But eventually, it just gravitated back in, despite the ED curve ending up rallying 18bps on the day. The green box is like the Terminator – it just keeps coming back. Part of this is that as the long end rallies and the curve becomes flat, there is less room for any variation. So this is understandable.
I wanted to discuss the other Terminator that is the EDU7-H8 spread – it just stays bid. Part of this is a high close. However, it seems awfully optimistic relative to the rest of the curve for this to be so high. I feel like I’m in Bizarro World, where the highest points in the green box are where I think they should be the lowest (post-Brexit), and the lowest point in the box (not including the end points) should be the highest. I basically think the spreads should increase to some point around the ED9-11 spread and decline thereafter. This would reflect my post-Brexit view (at other times, other shapes make more sense). Either someone’s algo needs some tweaking, or we still have more settling to do on the ED curve. Or both.
Interestingly, at the highs on Friday, the 6mo spread curve looked a lot like my “Bull” curve from two weeks ago (“Bull*” on the chart). Since we had the bullish event in “Brexit”, this makes some sense. But we have since come off of the highs, so I would have thought we would have settled (Friday’s settle is the red curve) more in line with the “Bull75*” curve – basically a smooth upward-sloping curve (but with higher spreads), since we have no idea what the fallout will be and how long the Fed will be on hold. But the actual settle on Friday was very kinked. Umm… WTH?!? That’s pretty strange, considering the markets think the next move is more likely to be an ease than a hike. Let’s see how this movie plays out. It should be entertaining watching the green box algo and the whatever *this* algo is trying to do resolves itself.
This is an amazing curve opportunity if it is still there Monday, and we have a strong view on direction. This is because in the weakness / recession scenario, it is almost impossible for the 6mo spreads NOT to be monotonically increasing through the reds. In other words, being able to sell a nearer term higher spread vs buying a lower spread further out is free money in a “sure” recession. The problem with the trade would be in a tightening environment. But if you can rule out the tightening environment, the spreads closer to the front should unequivocally be lower. Let’s see how things play out next week.
 I am showing the curves from 2 weeks ago, because the bears have not gotten over the shock of Brexit to know what to think, so I can not construct new curves.