For a while, every time a Fed official would talk about hiking, the curve would flatten. To give an idea of the flatness of the curve, note that in the beginning of 2014 the 2/10 treasury spread was 263 bps and the first red to first gold Eurodollar contract spread, (5th quarterly contract to 17th quarterly contract) was 306 bps. These curve spreads have been in a solid downtrend for 20 months. After the Fed hiked in December of last year the 2/10 spread went from 125 to a low of 75 (at the end of last month), and the first red to first gold ED spread went from 106 to a low of 37. (The reason I include the eurodollar spread is that it correlates well with the treasury spread, and is easier to express cleanly as a trade, doing equal quantities of each contract, while in treasury futures one must do a weighted ratio to equate DV01s). The point is that in the current environment, even as the Fed contemplates further rate increases, and even though the 3 month LIBOR rate has ALREADY risen 25 bps in a stealth regulatory tightening, the curve is edging steeper. For example, yesterday (Tuesday), the 2/10 treasury spread had bounced to 92 bps and the first red to gold to 51 bps.

AM915.gif

And it’s not just US rates that are trying to bottom. From the chart you can see ten year yields in Japan (red line), Germany (green), UK (white) and US (blue) are all moving higher.  And although this price action might be characterized as sideways in some cases, it’s still true that downward sloping trendlines have been violated in Japan, Germany and the US.  The market has been extremely complacent in thinking that longer end yields would never go up, and for a long time that has been the correct posture.  However, this incipient move in the yield curve is sending a warning signal.

For a trade, I would recommend buying EDH18 to EDH21 spread (buy near and sell deferred) at 52 bps (Tuesday settle).  Target 67 to 74 bps to initially sell half of the position.  Stop on close below 43 bps.