T-bond/T-note Spread: Trade Parameters Revised

The T-bond/T-note Spread Interval Ladder

Since October we have had a hypothetical order working to short the T-bond/T-note spread with parameters for increasing the position with an ‘interval ladder’ if it starts a down trend. With the continued price surge, we have room to bump up the entry parameters a bit higher.

Last week made history as the nearest-futures December T-bond/T-note spread rocketed to a new all-time high of 19-03.5. The March spread is not too far behind as it also posted a new contract high of 18-04.5 on December 16th.

March T-bond T-note spread daily

March T-bond T-note spread daily

On the daily timeframe, near-term technical support is located between the rising 30-day Moving Average around 15-24 (the March T-bond/T-note spread has not made a two-day close below the 30-day MA since September) and the November high of 15-18.5. (Old price resistance, once it has been broken, becomes new price support). A two-day close below the 30-day MA and a break back under the November high would signal a bearish trend change.

T-bond T-note spread weekly

T-bond T-note spread weekly

On the weekly timeframe, the T-bond/T-note spread finds technical support at the rising 20-bar Moving Average around 15-04. An end-of-week close below the weekly 20-bar MA for the first time in nearly a year would signal a bearish trend change. This could finally kick off a multi-month decline in the T-bond/T-note spread.

Since the T-bond/T-note spread usually follows the path of the 30-year Treasury bond, it is important to note the recent potentially bearish developments in T-bonds. First of all, the nearest-futures T-bonds traded as high as 147-30 on December 16th, which is just two ticks shy of the October 15 spike high at 148-00. The market then dropped sharply for a couple of days afterwards. This could be the makings of a double top formation on the charts. It was confirmed today when the market altered the bullish price structure by making a break below a previous week’s low for the first time since the November 7th correction low was established. This is an ominous sign for US Treasuries.

T-bonds (nearest-futures) daily

T-bonds (nearest-futures) daily

Secondly, consider the fact that T-bonds are currently poised for a fourth place tie with 2011 for the biggest annual gains since the Great Depression era. Looking at the ten best annual performances in this time period, eight of them were followed by a loss the next year. The two years that managed to extract more gains from T-bonds were 1986 with a gain of approximately 13 full points and 2012 with a gain of approximately two and three-quarter points. Therefore, probabilities are against another gain for T-bonds in 2015 and the odds of a sizable gain are even less favorable. This implies that the T-bond/T-note spread is headed for a decline in 2015.

Trade Strategy:

Cancel the hypothetical order to sell a March T-bond/T-note spread on a close below 13-24 (premium T-bonds) and replace it with a new hypothetical order to sell one March T-bond/T-note spread on a two-day close below the rising 30-day Moving Average (currently around 15-24) or an end-of-week close below the rising weekly 20-bar Moving Average (currently around 15-04), basis the nearest-futures. If filled, the position will be liquidated on a two-consecutive day close 8/32nds (one-quarter point) above the contract high that precedes the entry (currently at 18-04.5). In addition, continue to short more March T-bond/T-note spreads (single contracts) on each close that is 2-08 lower than the prior entry price until a total of four units (the initial entry position plus three ‘add-ons’) have been accumulated. For a trailing stop, all units will be liquidated on a two-consecutive day close 2-08 (two and one-quarter points) above the most recent entry price.

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