Thursday, December 24, 2009

The Debts of the World: Bond Vigilantes Place Bets on US Treasuries for 2010

The US bond vigilantes are adding to their bets by placing shorts against treasuries:

The most interesting story for the beginning of 2010 is the dollar and its correlation w/the safe haven trade of US treasuries. Everyone knows how the dollar has traded inversely to commodities. But the real story is to be found in the dollar-bond relationship. Normally, dollars and bonds rise in tandem as a flight to safety trade. But as the economic data improves (we can argue about all day about the validity of the official data but ultimately the official data is what moves the market and successful traders long ago figured not to fight the tape) so has the dollar's strength!

This means we can have a higher dollar and weaker bonds at the same time. But don't weaker bonds mean automatically higher stocks? Not necessarily. After the global equity indices explosive rally this year, there isn't much room left to grow.

The following comments goes towards my point earlier this month about EUR/USD.

I predict that fund flows from major institutions will be sloshing around the global financial system in a quest to figure out which country is weakest and thereby short that nation's bonds. The dollar, by virtue of its reserve currency status, will benefit from this comparative weakness. This means we can see market corrections among the most popular carry trades like AUD/USD and BRL/USD w/spillover effects in weaker commodity prices as well as gold.

But in the short term, as the 2-10 year spread approaches record steepness, it may be time to become a bull for the longer end of the curve. Especially after stories like this hit the media.

Further out, I have been considering placing bear put spread trades against the longer end of the curve by buying closer otm strikes on 30 year puts (LEAPs) while selling the same month strike further otm on the same expiration. 2011 and 2012 look like interesting bets w/2012 obviously safer because theta works in the call buyer's favor.

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