Asking for advice on S&T interview trading idea
Hi, I am writing here because there might be one S&T FICC interview upcoming. Interviewer may ask me for some opinions about market trading strategy. Therefore, I observe recent market and think about several about bonds, rates and currency. Would anyone help to review or correct my thought?
I would like to long 10yr T-bond and short 1yr T-bill (10yr/1yr curve flattener), reasons as:
1) Short term yield is more affected by monetary policy and the Fed rate is already set at 0 level, which means little room for 1yr rate increasing in short period; 10yr yield on the other side is affected more by expected inflation rate and Demand&Supply. At this period of recession and volatile situation, investors are more inclined to long term bonds with low inflation rate, thus the 10yr yield would come down.
2) From statistical research, the spread is larger than the average spread from 2018 till now. (2018-2020 is a good benchmark period since the large spread before 2018 is due to high inflation and low range of fed fund rate)
Any help：) thanks
Your thought process isn't totally wrong, but 1y is probably too short for your view to materialize on the front leg given why the curve is "steeper" right now. You need to think about what your time frame is as well.
Fundamentally, we've bull steepened as the Fed cut rates so the market naturally moves "growth" in the form of nominal yield further out the curve. So it's actually the opposite of what you're saying, when the market is in a cutting cycle (aka now) the curve is likely to keep steepening and when the market is in a hiking cycle, the curve is likely to flatten. Typically the curve flattens as the Fed raises rates (or the market starts to price in rate hikes in the near term) aka bear flattened as the market takes away "growth" further out the curve. I would look at 2s10s as there might be enough time for the market to start pricing in hikes again. Remember in 6m time, your trade effectively becomes 6m9.5y.
Thank you Koalamacro for the reply! If I understand correctly, I am betting on the view that Fed raise rate in the future, if I think the curve will flatten. And also, what if my time frame is much shorter than you said, say 2-3 months? Since I expect the economy would recover after this pandemic in near future? Thanks!
Yes exactly. When the market starts to price that in, you would see the front of the curve price appropriately by selling off by more or less the expected number of rate hike going forward to that point. The 10y would sell off, but it would certainly sell off less than the 2y (in some cases it could actually remain unchanged vs the 2y).
You're theoretically right, but I would say that time frame is too short. The Fed has been pretty hesitant to raise rates in the past. Even though this situation is rather unique in that it isn't a structural recession, they would still likely need to see at least consecutive months of strong / improving data (employment, consumer/business spending, inflation, etc.) for them to even consider it. Best case even if we got a "v-shaped" recovery, I think it would take them at least a year after the first few good data prints.
Thank you for your view, it really helps！
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I think people (not just you) wants to long 10yr t-bills because they automatically think the coming decade will be in a growing trend after the virus. But mind you coronavirus is a sudden event not a crisis like 2008 or anything near cyclical recession. Another crisis may hit shortly
Hey thank you. What you mean by another crisis, is it something about cyclical recession or you mean another black swan? I suppose another crisis would be the downside for this flattening strategy.
Can be any. We were already in recession before the virus hits, so next recession may hit within the 10-year horizon realistically speaking. Oh and political risk is considered to be the biggest global risk in many hfs and PEs, in other words we are looking at massive turbulence in the coming years
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