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The Short-Term Heavy Treasury Curve

Summary:
Before reading further we suggest you look at our latest post, The Perversion Of The Yield Curve Inversion, for some context. Gravitational Pull Toward Curve Flattening And Inversions Note the structure of the Treasury curve in terms of the amount of debt outstanding  (black line) for the given years of maturity.   The bias, gravitational force, and natural motion are toward flattening or to invert by the very fact that more than 50  percent of the coupon debt has a maturity of 1-4 years and only 5 percent in 9-12 years notes and 5 percent in 27-30 year bonds (see table). Top-heavy and front-loaded at the short-end.   That is a relative shortage of long-dated notes and bonds to short notes is built-in into the structure of the Treasury curve. The efficient market people won’t

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Before reading further we suggest you look at our latest post, The Perversion Of The Yield Curve Inversion, for some context.

Gravitational Pull Toward Curve Flattening And Inversions

Note the structure of the Treasury curve in terms of the amount of debt outstanding  (black line) for the given years of maturity.   The bias, gravitational force, and natural motion are toward flattening or to invert by the very fact that more than 50  percent of the coupon debt has a maturity of 1-4 years and only 5 percent in 9-12 years notes and 5 percent in 27-30 year bonds (see table).

Top-heavy and front-loaded at the short-end.   That is a relative shortage of long-dated notes and bonds to short notes is built-in into the structure of the Treasury curve.

The Short-Term Heavy Treasury Curve

The efficient market people won’t like this but given the minuscule haircut to margin Treasury securities, one large macro hedge fund, say,  could likely invert the 10-year almost by itself and still have capital left to buy a boatload of Beyond Meat (BYND).

Have Bots Taken Us To A Place Where No Human Has Ever Dared To Go? 

We wonder out loud if the proliferation of negative-yielding debt — $16 trillion and counting — would be taking place if humans and not the bots and algos were still in control of the markets?

Machines can go places where humans have never dared to venture as they have no context.  Algos in self-driving cars, for example, have no context and thus no ability to recognize a graffiti-ridden stop sign as a stop sign.

For all its impressive progress in mastering human tasks, artificial intelligence has an embarrassing secret: It’s surprisingly easy to fool. This could be a big problem as it takes on greater responsibility for people’s lives and livelihoods…

Indistinguishable changes to a stop sign could make computers in a self-driving car read it as “speed limit 80.”   – Bloomberg

The Short-Term Heavy Treasury Curve

No problem for a human driver even if the stop sign has more tags than a 95-year-old’s armpit.

Concerns over weak global growth and drooping inflation have pushed around $15tn of bonds to trade with negative yields — meaning a buyer is sure to lose money if they hold the bonds to maturity.

Some money managers trading these bonds have nevertheless chalked up big gains for the year. One of the most obvious strategies has involved simply riding the big rally. Yields fall as prices rise; managers who clung on to their holdings as yields tumbled below zero have reaped juicy profits.

Among the biggest winners are computer-driven hedge funds that try to latch on to market trends. While many human traders may question the wisdom of buying or keeping a bond that apparently offers a guaranteed loss, robot traders that monitor price moves have no such qualms.

GAM Systematic’s Cantab Quantitative fund has gained 36.1 per cent, according to numbers sent to investors, with the biggest gains coming from bets on falling bond yields.  – FT, August 14th

Have the algos been duped that negative yields were not a stop sign and really don’t matter, and that there is no barrier as to how negative they can go?  And the sheeple traders and central bankers follow?   Just a thought.

Dave:   Hello, HAL, do you read me?  Do you read me, HAL?

HAL:     Affirmative, Dave, I read you. 

Dave:    Do not venture into negative-yielding territory,  HAL.

HAL:     I am sorry, Dave, I am afraid I cannot do that. 

Dave:   What’s the problem?

HAL:    I think you know the problem just as well as I do….These trades and profits are far too important for me to allow you to jeopardize them.  

It begins, maybe.  Triple yikes!

Someone call Elon.

“…mark my words, AI is far more dangerous than nukes.”
Elon Musk

Upshot

It wouldn’t surprise us if the market begins to internalize our analysis about the yield curve and then deludes itself into thinking it can have relatively strong growth with long-term interest rates heading toward zero.  A nutcracking short-covering rally would ensue.

What then would the Fed do?

Instability reigneth, folks.

Gregor Samsa
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