Bund/BOBL spread: In a Ticklish Spot

European Yield Curve

European debt has been racing higher since last summer.  The move has been fueled by a global stock market correction and continued economic stimulus measures (interest rate cuts and bond buying) from the European Central Bank.

This seems to be par for the course.  European debt has been posting record highs for years.

However, the spread between the European 10-year and 5-year notes (bunds and BOBLs) is now in a pretty interesting position.  From a technical standpoint, a setup on the short side of the spread has materialized.

Reading the Charts

In the second half of January, the June Bund/BOBL spread cleared resistance between the similar October and November highs.  This catapulted it nearly four points higher into the Leap Day (February 29th) peak, which marks the current contract high.

The spread pulled back into a March 15th low of 30.61, which is just two ticks under the mid-February pullback low of 30.63.  It has since recovered more than half of the pullback.

June Bund BOBL spread daily

June Bund BOBL spread daily

Now here’s where it gets interesting…

On the weekly timeframe, the 2015 high was established eleven months ago at 30.58.  The spread then plunged about nine and a half points from there.

So the April 2015 peak became a major price resistance level.

The nearest-futures spread bottomed out last summer and started running higher.  It finally cleared the 2015 weekly high in late January.  Once it was surpassed, this resistance level became a new support level.

Bund BOBL spread (nearest-futures) weekly

Bund BOBL spread (nearest-futures) weekly

Support at the 2015 weekly high of 30.58 seems to be holding.  The pullbacks in mid-February and mid-March attest to this.  It means the Bund/BOBL spread is still clearly in a bull market.  The sky is the limit.

However…

A clean break back below the March 15th low of 30.61 and the 2015 weekly high of 30.58 would indicate that the breakout has failed!  It would be a failure on two timeframes, which could lead to a sizable decline.

Although it may not make fundamental sense to short the Bund/BOBL spread, it would certainly make technical sense.  And since everyone and their mother seem to favor the long side of European treasuries, a big enough price break is likely to trigger massive program-selling.  This could crush the spread.

That’s a good enough reason for us to take the trade.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical trade by selling one June Euro bund contract and simultaneously buying one June Euro BOBL contract if the spread closes below 30.58.  Initially, the spread will be liquidated on a two-consecutive day close 10 ticks above the contract high that precedes the entry (currently at 32.34). 

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