Bund/BOBL spread: Exit June Contracts

Move to the Sidelines

The IMC blog is holding a short position in the June Bund/BOBL spread that was originally entered on October 10th.  Due to rollovers, the entry price is the equivalent of 30.73.

The nearest-futures Bund/BOBL spread has been stuck in a consolidation zone for the last few months.  Initially, the trading range was defined by the price range that followed the bounce in the second half of December.  But a failed breakout above the range in late February and a failed breakout below the range in early March reset those boundaries.  After that, it’s been about as exciting as watching paint dry.

Bund BOBL spread (nearest-futures) daily

Bund BOBL spread (nearest-futures) daily

The September spread is priced more than a full point higher than the June spread and is currently trading higher than the late February price peak, basis the nearest-futures.  Therefore, the expiration of the June contracts will cause the nearest-futures chart to show a breakout above the top of the range.  This is bullish price behavior and not a good development for bearish bets on the European yield spread.  On this basis, the blog is going to simply exit the June spread without entering a September spread.  In other words, we’re not rolling over.

Since at least December, the September Bund/BOBL spread has made a series of higher lows.  A double top that was established at the January and February highs was surpassed at the end of April below a pullback occurred into the first half of May.  This is bullish.

The spread has been in an upswing since the May 9th correction low was established 29.95.  So far, three-quarters of the pullback has been recovered.  Things still look good for the bull side of the spread.

September Bund BOBL spread daily

September Bund BOBL spread daily

A break of the May low would throw a wrench in things as it would put the nearest-futures spread back into the trading range and also crack near-term price support for the September spread.  This would be a good reason to reenter a short position.

Trade Strategy:

Exit the hypothetical short position in the June Bund/BOBL spread at the market.  Work a hypothetical order to short the September Bund/BOBL spread on a close below the May low of 29.95.  If filled, liquidate the position on a two consecutive day close above the contract high that precedes the entry (currently at 32.15).

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Bund/BOBL Spread: Roll to June

Thinking About Summer

The IMC blog is holding a short position in the March Bund/BOBL spread that was entered at the equivalent of 31.93 on October 10th.  March contracts expire soon, so we’re going to roll to the June contracts.

The June spread closed at 28.94 on Friday, which is nearly a one and a quarter point discount to the March spread.  This puts the new spread right at a support zone on the weekly nearest-futures chart between the December and January lows of 28.91 and 29.09, respectively.  Once this support level is broken, there is nothing to stop the Bund/BOBL spread from descending to the next technical support level at a weekly Fibonacci .618 retracement at 26.13 (as measured between the 2015 low and the 2016 high.

euro-bund-euro-bobl-spread-weekly

Euro Bund Euro BOBL spread weekly

If the spread does not end its decline somewhere around this important support level, it may try to replicate the 9.40-point decline from last year’s record high.  If so, the next downside target will be at 24.74.

Trade Strategy:

Exit the hypothetical short March Bund/BOBL spread and simultaneously enter a short June Bund/BOBL spread at the market-on-close on Monday, March 6th. 

T-bond/T-note Spread: Roll to the June Contracts

Waiting For the Next Shoe to Drop

The IMC blog initiated a short position in the March T-bond/T-note spread at 26-18 (premium bonds) on January 20th.  For the last month, we’ve had little to show for our efforts as the spread has remained range-bound.

However, the spread did flash a major bearish signal back in early October when it closed below the widely-watch 200-day Moving Average for the first time since the first week of 2016.  We felt that the right move was to get short once the rally off the December low started to fade.  We still think that.

t-bond-t-note-spread-50-and-200-mas-daily

T-bond T-note spread (50 and 200 MAs) daily

A breakout above the current trading range would be our signal to take a loss on this initial trade and get to the sidelines.  If that occurs, it would increase the possibility of a rally to resistance at the declining 200-day MA where we would watch for a setup to take another crack at it.  Until then, we simply stay short.

First Notice Day for the March treasury contracts is on Monday.  Therefore, we have to roll to the June contracts today in order to maintain our position.

Trade Strategy:

Liquidate the short March T-bond/T-note spread and simultaneously enter a short June T-bond/T-note spread at the market-on-close on Friday, February 24th.  Risk the June spread to a two-day close above 27-24.  

T-bond/T-note Spread: Time to Get Short?

Dead Cat Bounce

The US treasury market spent the last half of 2017 going straight down.  An improving economy, a December rate hike with the prospect of more to come, the post-election stock market explosion, and ideas that a Trump victory will make things even better have caused traders and investors to abandon bonds as quick as possible.

For the last month, however, the treasury market has bounced back on ideas that the meltdown has been overdone.  From a technical standpoint, this looks like nothing more than a “dead cat bounce” or a correction in an overall downtrend.  If so, this is a short sale opportunity.

Yield Curve Spread

As readers know, the IMC blog is all about trading the intermarket spreads.  Treasuries are no exception.  Therefore, our interest lies in identifying trade opportunities in the T-bond/T-note spread.  Old time traders may remember this one as the NOB spread (Notes Over Bonds).

One thing you may notice on the blog is that we often trade the T-bond/T-note spread at a ratio of 1:1.  Many yield curve traders do this spread at a ratio of 3:1 where they have three ten-year note contracts for every one thirty-year bond contract.  This is done to account for the higher volatility on the longer end of the yield curve and smooth out some of the volatility.

The reason I have always done a ratio of 1:1 is to get positioned for a more directional bet.  This allows me to take a smaller spread position that I would have to do with a 3:1 ratio to match my risk appetite.  It also means I pay less in commissions.

There’s no right or wrong here.  It’s a choice to make based on your personal preference.

The Last Few Weeks

The nearest-futures T-bond/T-note spread rallied nearly three full points off the December multi-month low.  This bounce is a little bigger than the two and a quarter point bounce off the September low.

So either this is an ‘overbalancing of price’ that marks a trend change…or it’s the perfect place for the decline to quickly resume and take the T-bond/T-note spread to new lows.

I’m sure someone reading this is saying, “Gee, smart guy, that’s not much help.  You’re saying it could go either way then!”  Well, that’s just the first observation of the recent price action.  Let me put another layer of technical analysis on top of that to bring some more clarity.

Trend Parameters

Most market technicians are familiar with the 200-day Moving Average.  It’s probably one of the first things you learned about when you started charting.  The 200-day MA is a cornerstone metric used to determine the long-term market trend.

In late February of 2014, the nearest-futures T-bond/T-note spread made a sustained close above the 200-day MA for the first time in nine months.  This bullish trend change signal did its job well as it carried the spread higher for nearly two and a half years.

Who says that trend following is dead?!

Now, we do have to acknowledge that there was a brief period of choppiness in late 2015 when the spread dropped below the 200-day MA in the first part of November for a few days and recovered.  It then dipped back under the 200-day MA again for a few days at the December and recovered right after the new year began.  These were both false bearish trend change signals.  Other than that, though, the spread maintained itself above the 200-day MA.  So it still works a lot more often than not.

After topping at a record high last July, the spread pulled back, hit a trading range for several weeks, and then started to work lower again right after Labor Day.

On September 16th the T-bond/T-note spread came within spitting distance of that widely-watched 200-day MA.  Apparently, the significance was not lost on market participants because that’s where the big bounce happened that we talked about earlier.

The Game Changer

The bounce off the mid-September low faded as the third quarter drew to a close.  Then something very significant happened in the first week of October: the T-bond/T-note spread dropped to a new multi-month low and made a sustained close below the 200-day MA for the first time since the first week of 2016.

This was a major bearish trend change signal.

t-bond-t-note-spread-200-ma-daily

T-bond T-note spread (200-day MA) daily

Over the next two months, the T-bond/T-note spread dropped an additional nine full points.  That’s a big deal in Treasuries!  This spread is in a bear market, folks.

Zooming In

Take a look at how the spread has reacted to the 50-day Moving Average as well.  After peaking in early July and then hitting a trading range in August, the T-bond/T-note spread made a two-day below the 50-day MA for the first time in over three months.

In the first part of September, the 50-day MA also started to roll over.  This tipped the scales further in favor of the bears.

t-bond-t-note-spread-50-ma-daily

T-bond T-note spread (50-day MA) daily

Interestingly, the rally off the December low pushed the spread up enough to finally get a close back above the 50-day MA this week.  This is either an early warning that a bullish trend change is coming or it’s the maximum stretch point before the rubber band snaps back.

The spread is starting to sell off today.  A close under the 50-day MA today could indicate that technical resistance held and that the bounce is over.  Therefore, this provides a setup for a short sale.  We are willing to take it and see if this Friday the Thirteenth is our lucky day.

march-t-bond-t-note-spread-daily

March T-bond T-note spread daily

Here’s one more for the road: On November 3rd the 50-day MA closed below the 200-day MA for the first time in nearly nine months.  This was a classic death cross signal.  Who wants to fade that?!

t-bond-t-note-spread-50-and-200-ma-daily

T-bond T-note spread (50-day and 200-day MA) daily

Trade Strategy:

T-bond/T-note Spread

The blog will make a hypothetical trade by shorting one March T-bond contract and simultaneously buying one March T-note contract if the spread closes below the 50-day Moving Average (currently at 27-01).  Initially, the spread will be liquidated on a two-consecutive day close 8/32nds (one-quarter of a point) above the 2017 high (currently at 28-00).

Bund/BOBL Spread: Roll With the Bear

Out With the Old, In With the New

The IMC blog entered a short position in the December Bund/BOBL spread at 31.81 on October 10th.  The December European treasury futures contracts are expiring soon, so it’s time to roll over into the March contracts.

We noted in September that the close below the rising 30-bar Moving Average on the nearest-futures weekly chart for the first time in a year could have marked the beginning of a multi-month decline.  That’s how it played out the last two times the spread cracked the weekly 30-bar MA.

euro-bund-euro-bobl-spread-nearest-futures-weekly

Euro Bund Euro BOBL spread (nearest-futures) weekly

Another bearish development occurred one month ago.  The Bund/BOBL spread closed back below the 2015 high of 30.58.  Remember the old charting rule: Old resistance, once broken, becomes new support.  Well, that support level gave out four weeks ago.  This confirms that the trend has indeed turned bearish.

Where To Now?

A Fibonacci .618 retracement of the move from the 2015 low to the 2016 high would take the spread down to 26.13.  That’s another three full points from here.

But that does not mean the decline has to stop at Fibonacci support.

If the current decline from the 2016 record high replicates the 9.40-point decline from last year’s record high, the Bund/BOBL spread would hit 24.74 before it’s all over.

The bottom line is that the spread continues to break layers of technical support and the next targeted support area is still a few full points away.  Therefore, it makes sense to simply roll the contracts over and stay short.

Heck, we may even be willing to add to the position if the right setup comes along!  We’ll keep you posted if we see something interesting.

Trade Strategy:

Exit the hypothetical short December Bund/BOBL spread and simultaneously enter a short March Bund/BOBL spread at the market-on-close on Wednesday, December 7th.  Initially, the spread will be liquidated on a two-consecutive day close above 34.30. 

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

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

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

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). 

Bund/BOBL spread: Stalking a Short Sale at Record Highs

Whiplash

The IMC blog initiated a short position in the December Bund/BOBL spread at 32.12 on September 9th.  It then only took two weeks for the spread to reverse from a two-month low of 31.89 to a new contract high.  This was quite a reversal on the daily timeframe.  Consequently, the position was exited with a loss at 33.90 on September 28th.

The spread also did an about-face on the weekly charts.  The first week of September was marked by a close below the rising 30-bar Moving Average for the first time in a year.  The prior two times this happened, the Bund/BOBL spread continued to decline for months following.

As it turns out, the third time was not the charm for the Bund/BOBL spread.

Time to Reload

Despite the trade loss, traders should be looking to reload their guns and setup for another shot.  On the weekly timeframe, the Bund/BOBL spread is merely returning to where it previously peaked at an all-time high in late July.  A break back below the September low would put the spread back in a bearish position as it would both be below the weekly 30-bar MA again and triggering a Turtle-style (Donchian band) breakout to the downside.

euro-bund-euro-bobl-spread-30-bar-ma-weekly

Euro Bund Euro BOBL spread (30-bar MA) weekly

Furthermore, a break of the September low after the recent breakout to new highs could accelerate a downward move as anyone who went long on this breakout would likely get their liquidation parameters triggered.  We want to be short if that happens.

Trade Strategy:

The blog will work a hypothetical order to short the December Bund/BOBL spread on a close below the September low of 31.89.  Initially, the spread will be liquidated on a two-consecutive day close 10 ticks above the contract high that precedes the entry (currently at 33.90). 

Bund/BOBL spread: Short Sale Parameter Revision

Trailing Along

For the last several months, the IMC blog has been stalking the Bund/BOBL spread for a short sale.  Basically, we’ve been trailing the spread with a contingency to get short on a break of a prior month’s low.

It hasn’t happened yet.

September Bund BOBL spread daily

September Bund BOBL spread daily

Trading for the month of July ended today.  The September Bund/BOBL spread finished with a new contract high.  A mid-month correction left an obvious price support area on the chart at the July low of 32.54.  Therefore, we are going to raise the short sale parameters to enter on a break of this correction low.

The Bund/BOBL spread is rocketing higher as negative interest rates in Europe continue to propel the treasury spreads.  Once the “rocket” runs out of fuel, though, a significant reversal is likely.

One way we may know that the fuel is gone is when the spread breaks below technical support on at least two timeframes.  The break of the mid-July low would do the trick on the daily timeframe.

On the weekly chart, the rising 30-bar Moving Average may be the trip switch to keep an eye on.  When the Bund/BOBL spread closed below the weekly 30-bar MA in 2013 and again in 2015, it continued to trend lower for months afterwards.

Bund BOBL spread weekly (30-bar MA)

Bund BOBL spread weekly (30-bar MA)

Therefore, a close below the weekly 30-bar MA for the first time since August of 2016 would confirm that a downtrend is in motion.  Once that happens, we will likely be positioned on the short side and looking to add.

Trade Strategy:

Cancel the current hypothetical order to short the Bund/BOBL spread and replace it with a new hypothetical order to sell one September Euro bund contract and simultaneously buy one September Euro BOBL contract if the spread closes below the July low of 32.54.  Initially, the spread will be liquidated on a two-consecutive day close 10 ticks above the contract high that precedes the entry (currently at 34.26). 

10-Year Treasury Spread: Canada vs.US!

Close Correlation with Canucks

The correlation between the Canadian 10-year bond and US T-notes is strong.  I mean, really strong.  As a matter of fact, whenever someone gets busted trading US treasuries on inside information about a jobs report or something like that, you’d wonder why they didn’t just trade the Canadian bond instead of the T-note in order to stay off the radar.

By the way, I am not actually advocating this.  If someone does this and gets caught, don’t blame me!

Canadian bond T-note overlay weekly

Canadian bond T-note overlay weekly

There are periods where the trends in these bonds can diverge for a bit, but it doesn’t seem to last more than a few months.  So any diversion could be a setup for a mean-reversion trade.

There are also periods where one treasury will move faster than the other.  If this pushes the spread to historically extreme levels, you have another potential opportunity for a reversal trade.

Way Up North

Don’t forget that treasuries prices trade inversely to the interest rates.  So the global bull market in treasuries means we’re in a global bear market for interest rates.

The Canadian economy is weaker than the US.  Therefore, their rates are lower, which means that their corresponding treasuries are higher.

In the cash market, the yield on the US 10-year note is at 1.57% while the yield on the Canadian 10-year bond is at 1.10%.  That may not seem like a big deal, but the 42% percent premium on the US yield has pushed the Canadian 10-year bond futures contract to a full 16-point premium over the US T-note futures contract.  This is a rich premium.

At the peak in 2006, the premium on the Canadian bonds was less than half of what it is today.  When the 2006 high was surpassed two years ago, the spread between the two treasuries more than doubled over the next several months.

Canadian bond T-note spread weekly

Canadian bond T-note spread weekly

The only other time that the premium on Canadian bonds has been this fat or higher was for a few months either side of the Y2K (non-)event.  By the end of the year 2000, Canadian 10-year bonds were trading at a discount to the US T-notes.

Suffice it to say, the current premium on the Canadian bond/T-note spread is at an historically high level.  This could create a breeding ground for a major reversal.

The Wall

In February 2015, the nearest-futures Canadian bond/T-note spread cleared the 16.50 mark.  It peaked out at 16.90 less than a week later and reversed on a dime.  The spread then plunged over six points over the next two and a half months.

In August 2015, the nearest-futures Canadian bond/T-note spread once again clipped the 16.50 mark.  It peaked out just one day later and started a two-month decline.  The drop ripped nearly four and a half points off the spread.

Canadian bond T-note spread (nearest-futures) daily

Canadian bond T-note spread (nearest-futures) daily

Just a week ago, the nearest-futures Canadian bond/T-note spread closed above the 16.00 level.  This is not quite the 16.50 mark that told us to set the timer for the reversal the last two times, but it’s getting close.  Based on the daily chart for the September spread, there’s a good reason to start monitoring the situation closely.

Will the Fib Stop Cause a Flip-Flop?

The September Canadian bond/T-note spread faces technical resistance at the Fibonacci .618 retracement of the entire decline from the January 15th contract high to the April 29th multi-month low.  That Fib level is located at 15.97.

September Canadian bond T-note spread daily

September Canadian bond T-note spread daily

Last Wednesday, the September Canadian bond/T-note spread closed slightly above the Fib retracement for one day.  It then backed off and has been sitting still for the last week.  Traditionally, the Fibonacci .618 retracement is an ideal point to look for a secondary lower top to form before a market starts another leg down.  If this happens in the spread, we’ll take a crack at the short side.  If not, we will simply trail it higher with moving short sale parameters.

It’s also a point of interest that the spread closed about a third of a point below the Fibonacci .618 retracement last month and then endured a correction.  The June 2nd high set price resistance that was surpassed on July 11th.  The fact that the spread is now back below the early June top is indicative of a breakout failure, or what we like to call a Wash & Rinse sell signal.  If prices continue to erode from here, a short sale could be warranted.

Trade Strategy:

Place a hypothetical contingency order to sell one September Canadian 10-year bond contract and simultaneously buy one September T-note contract if the spread closes below 14.93 (premium Canada).  If filled, liquidate the position on a two-consecutive day close .20 points above the rally high that precedes the entry (currently at 16.05).

US Treasuries: On the Sidelines

Gone Flat

The IMC blog initiated a short position in the September T-note/5-Year note spread at the equivalent of 9-12.5 on March 1st.  The spread was liquidated at 10-12.5 on June 13th.  This trade resulted in a loss of -$1,000.

T-note 5-year note spread daily (nearest-futures)

T-note 5-year note spread daily (nearest-futures)

On the nearest-futures chart, the T-note/5-Year note spread is less than one-quarter of a point shy of matching the multi-year high that was posted in February.  However, the September spread has closed well above it for the last four days in a row.  This puts it within striking distance of the 2012 top at 11-02.5.

Low Yield Contagion

The US interest rate spreads have continued to surge on safe-haven buying and ideas that the Fed will put off any further rate hikes in the near-term.  US economic data is not living up to expectations.

Furthermore, negative yields around the globe are spreading like a contagion.  Worries about next week’s Brexit vote have caused the 10-year Euro bund to hit a negative yield for the first time ever and the Swiss 30-year bond even went negative.

Seriously, who wants to lock in a negative rate –meaning that you are paying the government to borrow from you- for three decades?!  This is insane.

This is going on in Japan, too.  Their 10-year yield dropped to a new record in negative territory.

One of these days, people are going to pause and think about what they’re really buying when they purchase treasuries with negative interest rates.  When common sense starts trickling in, treasuries could experience a complete meltdown.  Therefore, spread traders should continue to monitor interest rate spreads for short sale opportunities.