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

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-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-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

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-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).

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.

Will Interest Rate Spreads Peak? Our Interest Is Piqued!

Interest Rate Spreads

The interest rate markets have historically provided many good spread trading candidates. Potential trading opportunities could be shaping up in a few of them right now.  

Some interest rate spreads are based on the relationship between debts of different durations for the same country. (For instance, the long-term US 30-year bond against a medium-term US ten-year note). This is a traditional yield curve trade. 

T-bonds T-notes overlay monthly

T-bonds T-notes overlay monthly

The spread between 30-year bonds and 10-year notes are extremely correlated as they almost always move together in the same direction.  As a crude rule of thumb, one could state that the only difference between these two markets is that the 30-year bond moves about 40% faster than the 10-year note.

Other interest rate spreads are based on the relationship between the debts of different countries with the same duration. (For instance, the US ten-year note against the Canadian ten-year bond). This is an inter-market Treasury trade.

Let’s take a quick look at the first kind of spread.  

The T-bond/T-note Spread

The Fed’s QE program has kept a bid in the US bond market for the last few years. This has pushed the US Treasury market to historic highs and rates to rock-bottom lows. The Treasury spread has also been affected.

T-bonds T-notes spread monthly

T-bonds T-notes spread monthly

Historically, the T-bond/T-note spread has usually been a good candidate for a short sale whenever the T-bonds reached a premium of five points or more over the T-notes. No matter how high it went, the spread would ultimately reverse and erase the entire premium. Even in the depth of the financial crisis when the T-bond/T-note spread reached an all-time high of nearly fourteen points (premium T-bonds) at the end of 2008, it ultimately collapsed. The spread made it back to ‘even money’ (meaning that the prices of bonds and notes were the same) a little more than four months after the peak.

For the last three years, however, the T-bond/T-note spread has stayed far north of the ‘even money’ mark. After posting a new all-time high of just over eighteen points (premium T-bonds) in November of 2012, the one-year decline ended just below five points with the T-bonds still trading at a premium to T-notes.

On Thursday, August 28th the T-bond/T-note spread traded one-quarter of a point shy of last year’s peak, basis the nearest-futures. It has recovered about two-thirds of the entire drop from the November 2012 all-time high. Here’s the $64,000 question: Is this a manifestation of the ‘new normal’ that Bill Gross talked about or is this just a prolonged deviation from the mean that will eventually experience capitulation?

Regardless of the longer-term answer, it would seem that the T-bond/T-note spread is vulnerable to some sort of a reversal in the medium-term. There are two fundamental reasons for this. First, the Fed continues to unwind their QE bond buying program and the consensus is that a rate hike will come in 2015. Second, the government is projected to auction off $238 billion in Treasury supply in the second half of the year vs. the $133 billion that was auctioned off in the first half of the year. That’s a noticeable increase in supply.

Timing the reversal is the real issue, of course. We are not economists; we are traders. Therefore, we must be right and at the right time. In this business, being right early is still being wrong.

Looking at the daily and weekly time frames, there are three possible signals that one can use to identify a bearish trend change signal in the T-bond/T-note spread:

T-bonds T-notes spread daily

T-bonds T-notes spread daily

On the daily time frame, the dip in early July is the only time since the mid-November low was made that the most-active T-bond/T-note spread traded below a prior month’s low. It was a mere two and a half tick infraction, at that! Therefore, a close below a prior month’s low would alter this bullish price structure.

Also on the daily time frame, the pullbacks have been pretty uniform. Since the mid-November low was made the T-bond/T-note spread made several pullbacks of one to one and a half points from the peaks before it reverses and races to new highs. Therefore, any decline of two points or more from the high would signal an overbalancing of price and alert us to a trend change.

T-bonds T-notes spread weekly

T-bonds T-notes spread weekly

On the weekly time frame, a bullish trend change was signaled at the start of the year when the nearest-futures T-bond/T-note spread closed above the declining 20-bar Moving Average (by at least one-quarter of a point) for the first time since May 2013. The spread has continued to close above the weekly 20-bar MA every week since. Therefore, an end-of-week close below the weekly 20-bar MA (by at least one-quarter of a point) could signal a bearish trend change.

Trade Strategy:

The blog will make a hypothetical trade by shorting one December T-bond contract and simultaneously buying one December T-note contract if the nearest-futures spread makes an end-of-week close below the weekly 20-bar MA (by at least one-quarter of a point). Initially, the spread will be liquidated on a two-consecutive day close 8/32nds (one-quarter of a point) above the contract high that precedes the trend change signal.