Euro Bund/T-Note Spread: End of the Run?

At the Limit

Euro bunds have been outperforming the US 10-year notes ever since the end of the Great Financial Crisis eight years ago.  This is because the US economy has been outperforming the European economy.

You read that right.

Our economy has been doing better, but Europe’s 10-year treasury has been moving up faster than ours.  This is because Treasury prices are inversely correlated to Treasury interest rates.  So another way of saying this is that Europe’s interest rates have been dropping fast than ours.

But the charts suggest that this could be about to change.


Euro Bund T-note spread (nearest-futures) weekly

First of all, our nearly eight-year run in the bund/T-note spread is similar in duration to the bull market that started during the early ‘90s.  The spread bottomed at the end of the summer 1992 and topped in late spring of 2000.  A decline followed that lasted nearly two and a half years.

Secondly, the size of the current bull market is mammoth.  The 1992-2000 bull market ran the spread up 31 1/2 points from the low.  That was quite an accomplishment.  But our bull ran matched that gain two years ago.  A sizable correction followed soon after, but the next leg higher took it into record gains as our bull market has now put on 42 full points since the December 2008 bottom.

Third Time’s the Charm

On the daily timeframe, the nearest-futures Euro bund/T-note spread made some noteworthy tops around the 36.00 level this year: The spread peaked at 35.99 on March 1st, it peaked again at 36.33 on August 26th, and may have peaked once more this very week at 36.38 on November 28th.


Euro Bund T-note spread (nearest-futures) daily

Based on the prior two tops, it stands to reason that the spread will at least descend to the 32.00 area again.  This is a good enough reason to take a stab at the short side of the Euro bund/T-note spread.

However, if this really is the end of the multi-year bull market, a sustained close below 32.00 could indicate that this is only the tip of the iceberg.  Based on history, it could be just the start of a multi-year bear market for the Euro bund/T-note spread.

Wash & Rinse

Now this is interesting.  The December Euro bund/T-note spread will expire in a couple of weeks.  The next spread to trade will be the March spread.  Usually, the March spread should be priced at a discount to the December spread to account for the carry-charge.  (This is because the interest rates on the further contracts are normally higher and the interest rate is inverse to the price).  But the March spread is priced at a premium of more than two and a quarter points over the December spread.  As a short seller, this is a gift.

The reason for the higher price in the March spread is because the March T-note is pricing in the expected increase in US rates.  The further divergence in monetary policy between Europe and the US is widening this spread.


March 2017 Euro Bund T-note spread daily

The chart pattern of the March Euro bund/T-note spread is what has my attention, though.  This spread had a double top established between the August 26th high of 37.81 and the September 28th high of 37.81.  Once this resistance barrier was cracked on November 22nd, the spread had nothing to stop it from rocketing higher and the double top barrier became a floor of support.

This morning the March Euro bund/T-note spread is trading back below the old double top.  A close below this price would indicate a failed breakout attempt.  I call this a Wash & Rinse pattern.  Quite often, a failed breakout can lead to a sizable move in the opposite direction.  Therefore, a close below the August and September highs would be a short sale signal worth taking.

Trade Strategy:

Place a hypothetical order to sell one March Euro bund contract and simultaneously buy one March T-note contract if the spread closes below 37.81.  Initially, the spread will be liquidated on a two-consecutive day close 10 ticks above the contract high that precedes the entry (currently at 38.81). 

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