Ari Says Get Long Steepeners

All the credit for the first part of today’s post goes to LongConvexity, the mysterious Ari-Gold-type hedge fund manager, who reminded me of the enormous seasonal effect in the US 5/30 year treasury yield curve spread.

For the past eight years, the US yield curve has been flattening like a banshee, with the 5/30 spread declining from 300 basis points, all the way to the current 102 bps.

Having a look at that chart, it’s difficult to find a period where the curve consistently steepened. But if we pull up the seasonal matrix, it becomes a little more obvious.

January has been the best month for steepening, but right behind, is September. If you remove the terrible 2011 performance, then September is almost every bit as good as January.

I am a big, huge, Alaskan Peninsular grizzly of a bear when it comes to fixed income, but sometimes I need to find ways to express that view without just putting it all on the dark side. Playing for a bear steepener is a great way to limit my exposure, and hopefully participate in a long end led down move.

The trade’s mechanics.

Although bond traders are familiar with putting on yield curve spread trades, some of us that dabble in many markets, are not quite so well versed. So I have provided the Bloomberg PDH2 hedging screen shot.

To institute the trade, you need to buy 100 five year futures for every 24 long bonds that you sell. Obviously for non-institutional traders, you could tame that down to something like 12 fives versus 3 thirties. That works out to approximately $600 per basis point. So if the 5/30 spread moved up 10 bps, then that should equal $6k.

I still hold to my belief that the bond market is set up for a big disappointment. Massive supply is coming down the pike. With the recent US dollar sell off, inflation is due to increase, and the hurricanes might finally resurrect the long-left-for-dead Phillips curve. Buying 5/30 steepeners here at 102, risking down to 92, and hoping for a move back up to 130 is my new trade.