Treasury Tuesday's

Good Evening All. It's a good thing I left writing this piece until later in the day with the massive moves we've seen in the Treasury market following Powell's hawkish comments. 

*POWELL: CAN CONSIDER WRAPPING UP TAPER A FEW MONTHS SOONER

I've been very vocal in my pushback on the market belief that the Fed will hike multiple times in 2022. I continue to stand by this view and believe that inflation is transitory, despite the belief by many that Team Transitory is dead. Nonetheless, this has left some bruises to my views, and certainly has rattled the Treasury market a little bit. The equity market has also slumped lower, and USD strength has been a big part of the day. 

What I find particularly interesting though about these comments from Powell is the curves reaction. Basically, the market seems to think that faster hikes will help to keep longer-term yields down. The 10y yield has dropped a whopping 20bps in the last couple of trading days. 

Source: Refinitiv

WHAT'S THE VIEW? 

I'm pretty comfortable with my previous analysis in the first edition of Treasury Tuesday's. I still think the 2y yield is too high. With the 2y at 50bps I really don't see the Fed hiking several times in 2022. I stand by my view that a maximum of one hike will be made in 2022. I see room for the 2y to drop to around 40bps by the year-end - particularly with the Omicron concerns. 

For the 10y, I see the current yield as too low. If we are in a higher inflationary environment, then I do still suspect the Fed will want to move to a higher level of rates. We must of course be wary of the long-term downtrend in the 10y, and I certainly don't expect this to break, but a move higher up to 1.8% seems reasonable to me over a 12 month horizon. 

For the long-end of the curve, I expect to see an increase here too, but only to around 2%, i.e. not as high as pre-pandemic levels. This is based on the view that the 30y should be relatively close to the long-term growth rate close to 2%. 

Expecting a steepening: 

Recently, we've seen a very big flattening of the Treasury curve (higher 2s, lower 10s) and I do expect this to unwind. I can certainly see big upside for the 10y if the right conditions materialise, whereas I don't see much more room for near-term 2y upside. 

The 2s10s spread (first chart above is very much flattened) and the 5s2s is the flattest it has been in over a month. 

TRADE IDEA: 

Open trade idea: Buy 2y Sell 10y Treasury bond. This will then be a play for wider spreads in the near-term. Timeline is for the next month. TP when the spread hits 130 bps (my guess would be 1.7% on 10s and 0.4% on 2s). SL at 80bps. 

In practice, this is done by Selling SHY (2y ETF) and buying IEF (7-10y).