10yr ShortInflation came in as expected. Large buying on the 10 year treasuries. Shorting to break new swing low.
10YJ2025 trade ideas
10 Year Yield The 10 year yield should follow the DXY or be very close. For the 10 year yield it has come into weekly resistance. The bond market decides what this rate is and then also determines the mortgage rates which are 250-300 basis points higher than the 10 year yield. For now the debt market is showing risk on assets are better at this time. This still puts a drag on the housing market with hi PE ratios and high mortgage rates. I expect a pull back into key demand before the inauguration of President Trump. Depending on legislation, this could mean stronger dollar and higher yields for debt with tariffs. Or a potential economic slowdown in 2025 and rates change. The HTF is bullish. But I am ready for pullbacks from this level.
$10Y_F breaking outTen year interest rates US are out and above a weekly pattern, higher rates in 2025?
10-year Treasury Yield Surging ahead last FOMC in 2024After a politically charged November, bond markets have shifted their gaze back to economic fundamentals, setting the stage for a crucial Federal Reserve meeting on December 17. Recent data—including a robust jobs report and rising inflation—have reignited debates over long-term yields and the Fed’s future rate trajectory.
With the Fed’s dot plot and 2025 outlook in focus, the bond yield rallies ahead of the meeting reflects heightened anticipation of pivotal policy signals. This piece unpacks the dynamics driving Treasury yields and explores a potential trade setup deploying CME Yield futures to navigate the unfolding market environment.
MARKETS ARE FOCUSSING ON ECONOMIC DATA AGAIN
In November, U.S. Treasury yields were more influenced by political factors than by economic data. The 10-year Treasury yield remained largely unchanged after the 13/Nov CPI report, which showed headline CPI rising to 2.6% year-over-year in October, up from 2.4% in September. While the higher inflation suggested potential risks to bond yields—given that prolonged inflation could lead the Federal Reserve to slow its pace of rate cuts—Treasury yields were mostly unaffected by the data.
Instead, yields declined sharply when markets opened on November 25, following President Trump’s announcement of Scott Bessent as his pick for U.S. Treasury Secretary. Bessent, a fund manager, is anticipated to prioritize tax cuts and fiscal caution. The announcement drove the 10-year Treasury yield nearly 30 basis points lower over the next week, reaching its lowest level in over a month.
In the past two weeks, however, market focus appears to have shifted back to economic data. The non-farm payrolls report for November, released on December 6, exceeded expectations with 227,000 jobs added. Additionally, October’s dismal figure of 12,000 jobs was revised upward to 36,000, providing further support to the positive sentiment.
The improved jobs report soothed investor concerns, signalling that the state of the US economy may not be as bad as previously perceived. The jobs report eventually drove a 5-basis point recovery over the following week.
The latest CPI report for November also reaffirmed the trend that investors were focussing attention on economic data as 10Y yields surged after the report, rising nearly 19 basis points from the 09/Dec low.
10Y-2Y spreads have also surged by 8 basis points since 09/Dec. Investors can monitor the yield spreads using CME’s Treasury watch tool .
Source: CME TreasuryWatch
The tool can also be used to monitor the yield curve. Over the past month, the decline in Treasury yields has been concentrated in shorter-term tenors (2Y, 3Y, and 5Y), while the 30Y yield has remained largely unchanged. In contrast, the increase in yields over the past week has been more uniform across all tenors.
Source: CME TreasuryWatch
The November report showed inflation rising even further to 2.7%, although in-line with expectations, it suggests that inflation may be more persistent than previously perceived. This has led to expectations of a higher inflation premium for long-term treasuries which may have contributed to the rally in 10Y treasury yields.
FED DOT PLOT REMAINS THE HIGHLIGHT NEXT WEEK
Markets are almost certain of a 25-basis-point rate cut at the FOMC meeting on 17/Dec, with FedWatch indicating a 97% probability of this outcome as of 16/Dec. However, the primary focus will likely be on the Fed's guidance for the rate trajectory in the coming year. Alongside the rate decision, the Fed is expected to release its dot plot and summary of economic projections at the December meeting.
The December meeting is crucial as participants closely monitor the outlook for 2025. At last year’s December meeting, the Fed projected significant rate cuts in 2024, which triggered a substantial equity rally and a decline in bond yields.
Source: CME FedWatch
Per CME FedWatch, market participants expect an additional 50 basis points of rate cuts in 2025. However, the Fed's September dot plot indicated expectations for 100 basis points of cuts in 2025. If the December dot plot reaffirms the projection of 100 basis points, bond yields could decline sharply.
Source: Federal Reserve
BOND YIELDS HAVE RALLIED HEADING INTO THE MEETING IN THE PAST
The 10-year Treasury yields have rallied ahead of three of the last four FOMC meetings, with the increases notably concentrated in the three days leading up to the meetings. Given the recent trajectory of 10-year yields, a similar pattern may be likely this time.
The 10Y-2Y spread has shown a similar trend, increasing ahead of the last three FOMC meetings. However, following the November meeting, the 10Y-2Y spread declined. This suggests it may be prudent to position ahead of the meeting to mitigate potential post-meeting volatility.
Hypothetical Trade Setup
Market participants are nearly certain of a rate cut at the upcoming FOMC meeting, but the summary of economic projections is likely to carry greater significance. Currently, market expectations for rate cuts in 2025 are more conservative than the Fed's previous dot plot. If the Fed reaffirms expectations for more aggressive rate cuts next year, bond yields could sharply reverse their two-week rally.
While the 10-year yield outlook remains uncertain and subject to risk, the 10Y-2Y spread has a more optimistic trajectory. The spread stands to benefit from expectations of further rate cuts and its ongoing normalization trend. Additionally, historical trends suggest that positioning before the FOMC meeting may be advantageous, as the spread corrected after the last meeting.
Investors can express a view on the steepening of the 10Y-2Y yield spread using CME yield futures.
CME Yield Futures are quoted directly in yield with a 1 basis point (“bps”) change representing USD 10 in one lot of Yield Future contract. This simplifies spread calculations with a 1 bps change in spread representing profit & loss of USD 10. The individual margin requirements for 2Y and 10Y Yield futures are USD 330 and USD 320, respectively, at the time of writing. However, with CME’s 50% margin offset for the spread, the required margin drops to USD 325 as of 16/Dec, making this trade even more compelling.
The below hypothetical trade setup provides a reward to risk ratio of 1.94x:
Entry: 13.5 basis points
Target: 30 basis points
Stop Loss: 5 basis points
Profit at Target: USD 165 (16.5 basis points x USD 10)
Loss at Stop: USD 85 (8.5 basis points x USD 10)
Reward to Risk: 1.94x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme .
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Trump's Impact on Interest Rates: Higher Rates Ahead?After Trump’s decisive win on November 6th, Bitcoin, the USD, and yields (or interest rates) moved higher. In fact, these markets began moving upward in September, more than a month before Donald Trump became the 47th President of the United States.
We will study the direction of interest rates based on the actual market sentiment as reflected in U.S. bond yields.
10 Year Yield Futures
Ticker: 10Y
Minimum fluctuation:
0.001 Index points (1/10th basis point per annum) = $1.00
Disclaimer:
• What presented here is not a recommendation, please consult your licensed broker.
• Our mission is to create lateral thinking skills for every investor and trader, knowing when to take a calculated risk with market uncertainty and a bolder risk when opportunity arises.
CME Real-time Market Data help identify trading set-ups in real-time and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
Trump Presidency Ignites Bond Yields on Inflation ExpectationsThe “Make America Great Again” ethos has set the greenback on fire. Donald Trump's re-election has the US dollar surging 2%, extending its rally since early October to a total gain of 5%.
This resurgence is despite the anticipated 25 basis points (“bps”) rate cut at the November FOMC meeting. Dollar rally is driven by expectations of potential policy changes by the Trump Presidency.
HIGHER INFLATION EXPECTATIONS UNDER TRUMP 2.0
Trump’s election victory, combined with the Republican sweep of the Senate and the House of Representatives, gives the party the leverage to enact swift and substantial legislative changes.
His policies, such as corporate-friendly tax cuts & light-touch regulations, are expected to amplify corporate growth. These policies, combined with import tariff imposition, are expected to drive inflation higher. Rising inflation will curtail the pace of rate cuts by the Fed.
Rate cut expectations have eased since election. On November 6 (election day), projections pointed to rates reaching 350-375 bps on election day (6/Nov) per CME FedWatch tool. Now, they are expected to reach 375-400 bps.
Trump has previously pushed the Fed towards accommodative rate environment. Fed Chair Powell re-iterated that the Fed remains independent and data driven.
Source: CME FedWatch
Trump's proposed tariff policy will further strengthen the dollar. In August 2023, Trump announced plans for a universal 10% tariff on all U.S. imports, reiterating that tariffs on Chinese goods could be even higher, potentially reaching 60%-100%.
Such tariffs are expected to drive inflation higher. It will raise consumer prices and provoke retaliatory actions from trading partners, worsening inflation. Trump aims for these tariffs to revitalize American manufacturing and reduce reliance on imports which collectively support a stronger dollar.
STRONGER DOLLAR TRIGGER BOND YIELD SURGE
The resurgent dollar has contributed to the sharp rally in bond yields. The yield rally since October has resulted in the 10Y yield rising by 60 bps. Yields initially surged after the election result but partially reversed the following day after the FOMC meeting.
It currently stands 5 bps higher than the pre-election level.
Unlike the yield, the yield spread has remained flat since October. Higher for longer rates act to push this spread lower.
The Federal Reserve reaffirmed (at its Nov meeting) its dovish tone as Powell pointed to signs of an easing job market and slowing inflation. However, its impact on curbing bond yields was limited.
According to a JP Morgan report , while Fed Chair Powell has consistently conveyed a dovish tone over the years, the Fed's actual decisions have often skewed hawkish.
Although Powell’s dovish statements have initially brought bond yields down, the hawkish policy actions and Fed’s wait and watch approach that followed have typically led to renewed yield increases. This explains why yields continue to rise despite Powell’s dovish remarks at the November meeting.
HYPOTHETICAL TRADE SETUP
Treasury bond yields have been on the rise since October and Trump’s win has supercharged the rally. Investors are expecting higher inflation due to Republican policies which favour corporate growth.
Import tariff, if enacted, would have an even larger impact on the dollar and bond yields. However, actual policy plans remain uncertain for now.
While yields initially surged after the elections, they partially reversed shortly after as the Fed signalled a dovish stance. Despite this, the 10Y-2Y yield spread has remained unchanged.
Resurgent inflation will lead to the Fed slowing the pace of rate cuts. The recent reversal in yield spreads may be unsustainable given the expectation for slower rate cuts. When Trump administration announces policy plans, yields could surge even more strongly.
This week’s CPI release is anticipated to influence bond market movements. Analysts expect October’s YoY inflation to remain steady at 2.4%. If inflation holds at this level, it may have minimal impact, aligning with the Fed’s "watch and wait" strategy. However, a sharper-than-expected drop in inflation could reinforce expectations of quicker Fed rate cuts.
With the impact of inflation most apparent on the longer-tenor yields, investors can focus the position on the 10Y-2Y spread.
CME Yield Futures are quoted directly in yield with a 1 basis-point change representing USD 10 in one lot of Yield Future contract. This simplifies spread calculations with a 1 bps change in spread representing profit & loss of USD 10.
The individual margin requirements for 2Y and 10Y Yield futures are USD 330 and USD 320, respectively. However, with CME Group’s 50% margin offset for the spread, the required margin drops to USD 325 as of 12/Nov, making this trade even more capital efficient.
A hypothetical long position on the CME 10Y yield futures and a short position on the 2Y yield futures offers a reward to risk ratio of 1.3x is described below.
Entry: 6.2 basis points
Target: -11.5 basis points
Stop Loss: 20 basis points
Profit at Target: USD 177 ((6.2 - (-11.5)) x 10)
Loss at Stop: USD 138 ((6.2 - 20) x 10)
Reward to Risk: 1.3x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme .
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Yield Curve Reinverts on Easing Rate Cut ExpectationsFed sets the rates. Rates guide treasury yields. Fed remains data dependent. Incoming data creates nuanced shifts in yield spreads.
The September jobs report revealed 254,000 jobs added, significantly exceeding expectations of 147,000, with August figures also revised upward. This strong report, along with the JOLTS data from earlier in the week, indicates that the job market remains strong and not as weak as previously anticipated.
Despite the strong jobs data, the yield curve has inverted once again. While Mint Finance has previously highlighted that recession risks can lead to the yield curve inverting, that is not the only reason. This time around, the inversion is being driven by delay in rate cut expectations. CME’s Yield Futures enables investors to deftly express their views on the path of rates ahead.
JOB MARKET SHOWS MIXED SIGNS OF RECOVERY
The latest JOLTS figures showed U.S. job openings rising from 7.711 million to 8.090 million in August, with the previous month's numbers revised up by 38,000. Although job openings remain near a two-year low, the increase is a positive sign.
Rise in job openings was primarily due to increase in construction jobs (+138k), which are often seasonal, and government jobs (+103k). However, the overall report paints a mixed picture. Hiring fell by 99k from the previous month, and while total separations dropped by 317,000, the largest contributor was a 159,000 contraction in quits.
With fewer hires and a large drop in quits, the data suggests the job market is not particularly strong, as workers hesitate to leave their current positions with fewer being hired into new roles.
The Non-Farm Payrolls (NFP) showed 254,000 jobs added in September, with health care, social assistance, and leisure and hospitality sectors leading the gains. As a result of these additions, the unemployment rate eased to 4.1%. Hourly earnings grew by 4% YoY, with the previous month's figures revised upward to 3.9%.
RATE CUT EXPECTATIONS TEMPER
Further rate cuts are still expected, but the anticipated pace has slowed. Before the PCE inflation report on September 27, CME FedWatch indicated a cumulative 75 basis point reduction over the next two FOMC meetings in November and December.
Source: CME FedWatch
CME FedWatch tool also indicated a high probability of 100 basis-point cuts last month. However, after the encouraging PCE report, which showed inflation easing to 2.2%—its lowest level since 2021 and close to the Fed's target—the probability of a cumulative 50 basis-point cut has steadily risen.
Following the jobs report last week, the probability of cumulative 50 basis-points cuts surged to 80%.
The trend suggests that market participants are increasingly expecting a soft landing, with inflation easing and the job market remaining strong. A soft landing reduces the urgency for aggressive rate cuts, giving the Fed more flexibility to monitor the effects of previous rate hikes and lower rates more gradually.
Source: CME FedWatch
Crucially, Fed Chair Jerome Powell has suggested a similar outlook for rate trajectory. While speaking at the National Association for Business Economics, he suggested that if the economy continues on its current trajectory, he expects two more smaller rate cuts this year, or cumulative rate cuts of 50 basis points at the next two meetings. FOMC projections also signalled a similar rate outlook for 2024 as signalled by the dot plot below.
Source: FOMC
YIELD CURVE RE-INVERTS
Bond yields have increased sharply to their highest level since August on tempered rate cut expectations.
Crucially, the increase has been much sharper for the 2-year yields indicating near-term expectations of elevated rates for longer.
The result has been a re-inversion in the yield spread with 2-year & 10-year treasury yields now on par. Notably, the yield futures spread has declined more sharply than the treasury yield spread.
HYPOTHETICAL TRADE SETUP
Recent economic data points to rising likelihood of a soft landing. Expectations of rapid rate cuts have tempered accordingly. While rates are expected to continue declining, the pace is expected to slow with a cumulative 50 basis points (“bps”) of further cuts in 2024 likely.
As rates remain elevated for an extended period, the yield curve has begun to invert again. With current inflation easing, the inflation premium on long-term treasuries has diminished.
FOMC projections suggest a gradual path toward rate normalization, suggesting a potential near-term yield curve inversion before it eventually normalizes. Investors can express views on this outlook through CME yield futures.
Further, the yield futures spread is trading at a (~5bps) premium to the treasury yield spread, as the futures contracts approaches expiry on October 31, the futures spread will converge towards the treasury yield spread which further benefits the short position.
CME Yield Futures are quoted directly in yield with a 1 basis point (“bp”) change representing USD 10 in one lot of Yield Future contract. This simplifies spread calculations with a 1 bp change in spread representing profit & loss of USD 10. The individual margin requirements for 2Y and 10Y Yield futures are USD 330 and USD 320, respectively. However, with CME’s 50% margin offset for the spread, the required margin drops to USD 325 as of October 8, making this trade even more compelling.
A hypothetical trade setup comprising of long 2Y yield October futures and short 10Y yield October futures with reward to risk ratio of 1.5x is described below.
Entry: 13.5 bps
Target: -1.5 bps
Stop Loss: 23.5 bps
Profit at Target: USD 150 (15 bps x 10)
Loss at Stop: USD 100 (10 bps x 10)
Reward/Risk: 1.5x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme .
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
3 Standard Deviation Setup on Micro 10-Year Yield FuturesIntroduction
The Micro 10-Year Yield Futures contract has caught the attention of many traders recently, as its price action reached the upper 3 standard deviation of the Bollinger Band® in the daily time frame. This rare occurrence presents a potential mean reversion setup, where the price could revert back toward its historical average.
This article explores what mean reversion is, why it matters in trading, and how the 3 standard deviation Bollinger Bands® setup may indicate an opportunity to short this market. We’ll also discuss key price levels, contract specifications, and a potential trade setup for shorting Micro 10-Year Yield Futures.
What is Mean Reversion in Trading?
Mean reversion is a trading concept based on the idea that asset prices fluctuate around a central value or mean over time. When prices move too far away from this mean, they often correct or revert back toward that average. This is particularly useful in markets that experience high volatility or extreme price movements, as those extremes tend to reverse at some point.
In simple terms, mean reversion strategies involve selling (or shorting) assets when they are significantly above their historical average, with the expectation that prices will return to normal levels. Conversely, buying when prices are significantly below the mean can also be a valid strategy.
The 3 Standard Deviation Bollinger Band® Setup
Bollinger Bands® are a popular technical indicator used to measure volatility and price extremes. The bands are plotted a certain number of standard deviations away from a moving average. The further away prices move from the average, the more extreme the movement.
Reaching the upper 3 standard deviation Bollinger Band® is a rare occurrence that suggests extreme overbought conditions. Historically, when an asset reaches this level, the likelihood of a price pullback increases, as market participants may see it as an unsustainable level. In the case of Micro 10-Year Yield Futures, the recent rally has pushed prices to this rare zone, setting the scene for a potential mean reversion.
Key Price Levels and Resistance Zones
As the Micro 10-Year Yield Futures price approaches extreme levels, there are two key resistance zones which traders should be aware of: 4.174-4.021. These levels represent areas where selling pressure might intensify, pushing prices down and aiding in the mean reversion process.
Traders looking to capitalize on this potential mean reversion setup can consider initiating short positions within this resistance range. These resistance zones act as psychological and technical barriers, providing an opportunity for traders to place their entries. Additionally, these levels help to manage risk, as they define a clear area to set stop-loss orders just above the upper resistance.
Contract Specifications and Margin Requirements
Understanding the specifications of the Micro 10-Year Yield Futures contract is crucial for traders looking to execute any trade. Here are some of the key details:
Tick Size: The minimum price fluctuation is 0.001, which equates to $1 per tick.
Margin Requirements: Margin requirements vary. Currently, the initial margin for Micro Yield Futures is around $320 per contract, making it accessible to a wide range of traders. Check with your broker for specific margin amounts.
This knowledge is essential in calculating potential profit and loss in dollar terms, as well as determining the appropriate position size based on your available margin.
Trade Setup Example
Let’s now move on to a practical trade setup based on the discussed conditions.
Entry Point: Shorting Micro 10-Year Yield Futures within the resistance range between 4.174 and 4.021.
Stop Loss: A stop should be placed just above the upper resistance, say around 4.175, to protect against further price appreciation.
Target: The target for this mean reversion trade would be around the mean of 3.750, where prices are expected to revert based on historical behavior.
Reward-to-Risk Calculation:
If a short entry is made at 4.021, with a stop at 4.175 (154 basis points risk) and a target at 3.750 (271 ticks potential gain), the reward-to-risk ratio would be approximately 1.76:1. A higher entry point closer to the upper resistance at 4.174 would significantly improve the reward-to-risk ratio, but it also increases the likelihood of missing the entry if the market reverses before reaching that level.
In dollar terms, each tick (0.001) is worth $1, so the 154-tick stop loss represents a risk of $154 loss per contract, while the potential reward of 271 ticks equates to $271 worth of gains per contract.
Risk Management Considerations
Risk management is a critical aspect of any trading strategy, especially in futures trading. While the 3 standard deviation Bollinger Band® setup provides a compelling case for mean reversion, it's essential to manage risk carefully to avoid significant losses.
Stop-Loss Orders: A well-placed stop-loss is crucial to protect against unexpected market moves. In this case, placing the stop above the resistance zone (around 4.175) ensures that risk is controlled if the market continues to rally instead of reversing.
Position Sizing: Given the volatility of futures contracts, it is important to adjust position sizes according to the trader’s risk tolerance and available margin. Overleveraging can lead to large losses if the market moves against the trade.
Moving Averages Can Shift: It’s important to remember that the moving average (the mean) can change as new data comes in. While the target is currently around 3.744, this level may adjust over time, so traders need to monitor the mean as the trade progresses (which is why we have set the target to initially be slightly higher at 3.750).
Resistances as Reinforcements: The resistance zone between 4.174 and 4.021 can act as reinforcements to the mean reversion. Traders should observe price behavior at these levels to confirm rejection signals before entering the trade.
Conclusion
In conclusion, the Micro 10-Year Yield Futures contract presents a unique trading opportunity as it has reached the rare 3 standard deviation Bollinger Band® on the daily time frame. This extreme price level indicates potential overbought conditions, making it a candidate for mean reversion back to the mean at approximately 3.750.
The trade setup involves shorting within the resistance range, with a well-defined stop and target, and offers a favorable reward-to-risk ratio. However, as always, caution is advised, and traders should manage risk effectively using stop-loss orders and appropriate position sizing.
When charting futures, the data provided could be delayed. Traders working with the ticker symbols discussed in this idea may prefer to use CME Group real-time data plan on TradingView: www.tradingview.com - This consideration is particularly important for shorter-term traders, whereas it may be less critical for those focused on longer-term trading strategies.
General Disclaimer:
The trade ideas presented herein are solely for illustrative purposes forming a part of a case study intended to demonstrate key principles in risk management within the context of the specific market scenarios discussed. These ideas are not to be interpreted as investment recommendations or financial advice. They do not endorse or promote any specific trading strategies, financial products, or services. The information provided is based on data believed to be reliable; however, its accuracy or completeness cannot be guaranteed. Trading in financial markets involves risks, including the potential loss of principal. Each individual should conduct their own research and consult with professional financial advisors before making any investment decisions. The author or publisher of this content bears no responsibility for any actions taken based on the information provided or for any resultant financial or other losses.
FOMC Showdown Poised to Ignite a Surge in Yield SpreadsWith inflation finally cooling and the Fed signaling rate cuts, it seems relief is on the horizon—until you look at the job market. As recession risks grow and Treasury yields falter, a steepening yield curve presents a compelling opportunity.
Positioning in the yield curve ahead of the FOMC meeting offers a more measured way to navigate the uncertainty.
COOLING CPI SIGNALS GREEN LIGHT FOR RATE CUTS
This week’s inflation report showed headline CPI cooling to 2.5%, the lowest since February 2021. With this release, inflation has finally fallen decisively below the stubborn 3% mark and is now just 0.5% above the Fed’s target range. PCE inflation reflects similar levels, likely giving the Fed the signal to start cutting rates.
JOB MARKET REPRESENTS MATERIAL RECESSION RISKS
Recent job market data suggests it may be too soon to declare a soft landing. The labor market is significantly weakening, and with household savings dwindling and credit delinquencies increasing, conditions may worsen before improving.
U.S. economic data from the past week indicates that the labor market is in a precarious situation. The August JOLTS report showed job openings dropping to their lowest since early 2021, reflecting decreased labor demand, while unemployment edged up slightly.
Additionally, the August jobs report revealed a modest gain of 142,000 non-farm jobs, falling short of expectations, with downward revision for July bringing those figures down to just 89,000.
As covered by Mint Finance previously a recession is likely to lead to a sharp steepening of the yield curve.
We covered average levels of the yield spread at the start of recessions in detail previously, but in summary with the current 10Y-2Y spreads at 15 basis points, there may be up to 85 basis points of further upside in the spread.
TREASURY YIELD PERFORMANCE
Despite a short recovery following the ominous jobs report on 2/August, Treasury yields have continued to decline. Unsurprisingly, short-dated treasuries have underperformed as 2Y yields are 27 basis points lower, while 30Y yields have only declined by 12 basis points and 10Y by 15 basis points.
Overlaying yield performance with economic releases, the largest impact on yields over the last few months has been from FOMC releases and non-farm payrolls while performance around CPI releases has been mixed. Potentially suggesting traders are more concerned about recession risk than moderating inflation.
OUTLOOK FOR SEPTEMBER FOMC MEETING
Source: CME FedWatch
FedWatch currently suggests that a 25 basis point rate cut is more likely in the upcoming FOMC meeting scheduled on September 17/18. However, probabilities of a 50 basis point rate cut are also relatively high at 43%.
Source: CME FedWatch
While the odds of a 25 basis point cut have remained in majority, the 50 basis point cut has been uncertain with probability shifting over the past week.
FOMC meetings have driven a rally in yield spreads over the past year.
With FOMC meeting slated for next week, it is interesting to note that performance in yield spread prior to meetings has been more compelling than performance post-FOMC meeting. Over the last 5 meetings, pre-FOMC meetings, the 10Y-2Y spread has increased by 4 basis points.
Performance is even more compelling in the 30Y-2Y spread which has increased by an average of 13 basis points.
AUCTION DEMAND FAVORS 10Y
Recent auction for 10Y treasuries indicated strong demand with a bid/cover ratio of 2.64, which is higher than the average over the last 10 auctions of 2.45. Contrastingly, the 30Y auction was less positive with a bid/cover ratio of 2.38, below the average of 2.42. 2Y auction was sharply weaker with a bid/cover of 2.65 compared to average of 2.94.
Auction uptake suggests higher demand for 10Y treasuries than 30Y treasuries and fading demand for near-term 2Y treasuries.
HYPOTHETICAL TRADE SETUP
Recent economic data has made an upcoming rate cut nearly certain. However, the size of the cut remains unclear. CME FedWatch currently indicates a 42% probability of a larger 50-basis-point cut, driven by the recent CPI report and weak jobs data.
With rising recession risks, the Fed might opt for a larger rate cut. However, if they choose a moderate 25-basis-point cut, market sentiment could stabilize. Historically, yield spreads around FOMC meetings suggest that positioning before the meetings tends to be more advantageous than after. This is especially relevant now, as moderating sentiment from a 25-basis-point cut could trigger a temporary reversal in yield spreads.
Considering the underperformance of the 10Y-2Y spread in September and increased auction demand for 10-year Treasuries, a long position in the 10Y-2Y spread may be the most favorable strategy for gaining exposure to the steepening yield curve.
Investors can express views on the yield curve using CME Yield Futures through a long position in 10Y yield futures and a short position in 2Y yield futures.
CME Yield Futures are quoted directly in yield with a 1 basis point change representing USD 10 in one lot of Yield Future contract. This makes spread calculations trivial with a 1 basis point change in spread representing PnL of USD 10.
The individual margin requirements for 2Y and 10Y Yield futures are USD 330 and USD 320, respectively. However, with CME’s 50% margin offset for the spread, the required margin drops to USD 325 as of September 13, making this trade even more compelling.
A hypothetical trade setup offering a reward to risk ratio of 1.46x is provided below:
Entry: 14.2 basis points
Target: 35 basis points
Stop Loss: 0 basis point
Profit at Target: USD 208 (20.8 basis points x 10)
Loss at Stop: USD 142 (14.2 basis points x 10)
Reward to Risk: 1.46x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme .
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Zero Spread Milestone: Strategic Trade in Micro Yield FuturesIntroduction
The current market scenario presents a unique potential opportunity in the yield spread between Micro 10-Year Yield Futures (10Y1!) and Micro 2-Year Yield Futures (2YY1!). This spread is reaching a critical price point of zero, likely acting as a strong resistance. Such a rare situation opens the door for a strategic trading opportunity where traders can consider shorting the Micro 10-Year Yield Futures and buying the Micro 2-Year Yield Futures.
In TradingView, this spread is visualized using the symbol 10Y1!-CBOT_MINI:2YY1!. The combination of technical indicators suggests a mean reversion trade setup, making this a compelling moment for traders to act on such a potential opportunity. The alignment of overbought signals from Bollinger Bands® and the RSI indicator further strengthens the case for a reversal, presenting an intriguing setup for informed traders.
All of this is following last Wednesday, July 31, 2024, when the FED reported their decision related to interest rates where they left them unchanged, adding further context to the current market dynamics.
Yield Futures Contract Specifications
Micro 10-Year Yield Futures (10Y1!):
Price Quotation: Quoted in yield with a minimum fluctuation of 0.001 Index points (1/10th basis point per annum).
Tick Value: Each tick is worth $1.
Margin Requirements: Approximately $320 per contract (subject to change based on market conditions).
Micro 2-Year Yield Futures (2YY1!):
Price Quotation: Quoted in yield with a minimum fluctuation of 0.001 Index points (1/10th basis point per annum).
Tick Value: Each tick is worth $1.
Margin Requirements: Approximately $330 per contract (subject to change based on market conditions).
Margin Requirements:
The margin requirements for these contracts are relatively low, making them accessible for retail traders. However, traders must ensure they maintain sufficient margin in their accounts to cover potential market movements and avoid margin calls.
Understanding Futures Spreads
What is a Futures Spread?
A futures spread is a trading strategy that involves simultaneously buying and selling two different futures contracts with the aim of profiting from the difference in their prices. This difference, known as the spread, can fluctuate based on various market factors, including interest rates, economic data, and investor sentiment. Futures spreads are often used to hedge risks, speculate on price movements, or take advantage of relative value differences between related instruments.
Advantages of Futures Spreads:
Reduced Risk: Spreads generally have lower risk compared to outright futures positions because the two legs of the spread can offset each other.
Lower Margin Requirements: Exchanges often set lower margin requirements for spread trades compared to single futures contracts because the risk is typically lower.
Leverage Relative Value: Traders can take advantage of price discrepancies between related contracts, potentially profiting from their convergence or divergence.
Yield Spread Example:
In the context of Micro 10-Year Yield Futures and Micro 2-Year Yield Futures, a yield spread trade involves buying (or shorting) one contract (10Y1! Or 2YY1!) while shorting (or buying) the other. This trade is based on the expectation that the spread between these two yields will move in a specific direction, such as narrowing or widening. The current scenario (detailed below), where the spread is reaching zero, suggests a significant resistance level, providing a unique trading opportunity for mean reversion.
Analysis Method
Technical Indicators: Bollinger Bands® and RSI
1. Bollinger Bands®:
The spread between the Micro 10-Year Yield Futures (10Y1!) and Micro 2-Year Yield Futures (2YY1!) is currently above the upper Bollinger Band on both the daily and weekly timeframes. This indicates potential overbought conditions, suggesting that a price reversal might be imminent.
2. RSI (Relative Strength Index):
The RSI is clearly overbought on the daily timeframe, signaling a possible mean reversion trade. When the RSI reaches such elevated levels, it often indicates that the current trend may be losing momentum, opening the door for a reversal.
Chart Analysis
Daily Spread Chart of 10Y1! - 2YY1!
The main article daily chart above displays the spread between 10Y1! and 2YY1!, highlighting the current position above the upper Bollinger Band. The RSI indicator also shows overbought conditions, reinforcing the potential for a mean reversion.
Weekly Spread Chart of 10Y1! - 2YY1!
The above weekly chart further confirms the spread's position above the upper Bollinger Band. This longer-term view provides additional context and supports the likelihood of a reversal.
Conclusion: Combining the insights from both Bollinger Bands® and RSI provides a compelling rationale for the trading opportunity. The spread reaching the upper Bollinger Band on multiple timeframes, along with an overbought RSI, strongly suggests that the current overextended condition is potentially unsustainable. Additionally, all of this is occurring around the key price level of zero, which can act as a significant psychological and technical resistance. This convergence of technical indicators and the critical price level points to a high probability for a potential mean reversion, making it an opportune moment to analyze shorting the Micro 10-Year Yield Futures (10Y1!) and buying the Micro 2-Year Yield Futures (2YY1!) as the spread is expected to revert towards its mean.
Trade Setup
Entry:
The strategic trade involves shorting the Micro 10-Year Yield Futures (10Y1!) and buying the Micro 2-Year Yield Futures (2YY1!) around the price point of 0. This is based on the analysis that the spread reaching zero can act as a strong resistance level.
Target:
As we expect the 20 SMA to move with each daily update, instead of targeting -0.188, we aim for a mean reversion to approximately -0.15.
Stop Loss:
Place a stop loss slightly above the recent highs of the spread. The daily ATR (Average True Range) value is 0.046, so adding this to the entry price could be a way to implement a volatility stop. This accounts for potential volatility and limits the downside risk of the trade.
Reward-to-Risk Ratio: Calculate the reward-to-risk ratio based on the entry, target, and stop loss levels. For example, if the entry is at 0.04, the target is -0.15, and the stop loss is at 0.09, the reward-to-risk ratio can be calculated as follows:
Reward: 0.19 points = $190
Risk: 0.05 = $50
Reward-to-Risk Ratio: 0.19 / 0.05 = 3.8 : 1
Importance of Risk Management
Defining Risk Management:
Risk management is crucial to limit potential losses and ensure long-term trading success. It involves identifying, analyzing, and taking proactive steps to mitigate risks associated with trading.
Using Stop Loss Orders:
Always use stop loss orders to prevent significant losses and protect capital. A stop loss order automatically exits a trade when the price reaches a predetermined level, limiting the trader's loss.
Avoiding Undefined Risk Exposure:
Clearly define your risk exposure to avoid unexpected large losses. This involves defining the right position size based on the trader’s risk management rules by setting maximum loss limits per trade and overall portfolio.
Precise Entries and Exits:
Accurate entry and exit points are essential for successful trading. Well-timed entries and exits can maximize profits and minimize losses.
Other Important Considerations:
Diversify your trades to spread risk across different assets.
Regularly review and adjust your trading strategy based on market conditions.
Stay informed about macroeconomic events and news that could impact the markets.
When charting futures, the data provided could be delayed. Traders working with the ticker symbols discussed in this idea may prefer to use CME Group real-time data plan on TradingView: www.tradingview.com This consideration is particularly important for shorter-term traders, whereas it may be less critical for those focused on longer-term trading strategies.
General Disclaimer:
The trade ideas presented herein are solely for illustrative purposes forming a part of a case study intended to demonstrate key principles in risk management within the context of the specific market scenarios discussed. These ideas are not to be interpreted as investment recommendations or financial advice. They do not endorse or promote any specific trading strategies, financial products, or services. The information provided is based on data believed to be reliable; however, its accuracy or completeness cannot be guaranteed. Trading in financial markets involves risks, including the potential loss of principal. Each individual should conduct their own research and consult with professional financial advisors before making any investment decisions. The author or publisher of this content bears no responsibility for any actions taken based on the information provided or for any resultant financial or other losses.
Rapid Yield Curve Inversions as Recession Fears RealizedLast week was pandemonium for US Equities, Japanese Equities, Foreign Exchange markets, Cryptocurrency markets, and Bond markets. Yet, for those positioned for the normalization of the yield curve, results are apparent as the curve has officially normalized into positive territory with a sharp recovery on Friday which continued into Monday.
The non-farm payroll report highlighted concerns we previously illustrated that a recession is not off the cards yet.
In fact, the latest data suggests it may be likely. The Sahm rule, a strong indicator of past recessions, was activated based on the latest jobs data.
Given the possibility of a recession in the US, the further steepening of the yield curve remains a compelling opportunity with uncertainty persisting across all areas of the market. This paper provides a hypothetical trade setup in the 10Y-2Y spread to gain exposure to normalization.
LATEST JOB REPORT WAS DISMAL WITH LOW JOBS ADDED, RISING UNEMPLOYMENT
The Nonfarm payroll report from July showed a meagre 114k jobs added compared to expectations of 176k. Even worse, figures for May and June were revised lower by a cumulative 29k bringing the updated figures well below the initial analyst consensus for these months.
Job addition in July was one of the lowest since the pandemic. Moreover, both initial and continuing jobless claims last week rose to their highest level since 2021. Combined effect on the job market was an increase in the unemployment rate to 4.3%, the highest since 2021.
The job market is visibly weakening. Though the effect of Hurricane Beryl likely played a role in the dismal jobs report, the details suggest systemic weakening as both hiring and quits fell to their lowest level since 2020.
To make matter worse, conditions may worsen even further in the coming months as Intel announced plans to reduce its workforce by 15k at its most recent earnings.
JOBS REPORT TRIGGERS SAHM RULE
The Sahm rule is a recession indicator used to identify early signals of a recession. It measures the difference between the current unemployment rate relative to the lowest three-month average in the last 12 months. According to the Sahm Rule, a recession could be on the hoirzon when this value rises above 0.5, Currently, the indicator is at 0.53.
It is a highly accurate indicator, proven to be reliable through the last 12 recessions when the indicator was at present values.
While no indicator is completely accurate and past results do not guarantee future performance, the accuracy of the indicator should not be ignored.
RATE CUT EXPECTATIONS SURGE
As a result of the dismal jobs report, rate cut expectations have surged, largely due to expectations that the Fed will be forced to cut rates rapidly in response to a faltering economy.
For reference, at the September policy meeting, FedWatch signals a >90% probability of 50 basis point cuts. Just 1 week ago, FedWatch suggested a 10% probability for that decision.
Source: CME FedWatch
Markets are also expecting a 50-basis point cut at the November meeting followed by a 25-basis point cut at the December meeting for a cumulative cut of 125 basis points in 2024.
Source: CME FedWatch
BOND MARKETS IN TURMOIL BUT YIELD SPREAD SURGED
Due to the rapid reversal in sentiment, US treasury yields have fallen sharply. 2Y yield is 15% lower over the past week. 10Y yield has declined by 10% and 30Y yield has fallen by 8%.
On Friday, the decline in 2Y yield was the sharpest since 13/December when the Fed policy projections suggested up to six rate cuts in 2024. This time around, the decline in bond yield has been driven by market fears of a recession which may force the Fed to cut rates rapidly.
While the yields have declined sharply, yield spreads have surged. The 10Y-2Y spread has increased by 27 basis points over the past week with a 10-basis point jump on Friday followed by another 8 basis points increase on Monday.
The 30Y-2Y spread has been the strongest performer. It has increased by 63 basis points over the past week. It surged by 29 basis points on last Friday and another 14 basis points on Monday.
Both spreads have now normalized as 2Y yield has declined much more sharply than 10Y and 30Y yield. The normalization has brought to end the longest yield curve inversion in history that lasted more than two years.
This is not unexpected as highlighted by Mint Finance in a previous paper . The yield spread tends to normalize long before a recession actually arrives.
However, the spread may rise further. According to historical levels of the 10Y-2Y spreads at the start of previous recessions, there is between 15 and 100 basis points of further upside.
The potential for upside is even higher on the 30Y-2Y spread although in 1989, the level was lower than the current level suggesting the risk of a decline.
LONG 10Y SHORT 2Y ON FURTHER NORMALIZATION
While the movements in the yield spreads over the past week have been enormous, there is a potential for further increase. Recession signals are flashing red. Equity markets are in turmoil. Fed may be forced to reduce rates to support a weak job market.
Rapid rate cuts and a recession support further steepening of the yield curve. Historical performance of yield spreads prior to recessions suggests the yield curve may continue to steepen at a rapid rate.
We had previously suggested the 30Y-2Y spread as a superior instrument to express views on this normalization. However, the 30Y-2Y spread has surged by 63 basis points in the past week. While it may continue to rise even further, there is a risk that markets have exhausted much of the upside. A position on the 10Y-2Y spread offers potentially higher upside.
The 10Y-2Y spread is just above the level of 0 indicating the potential for further recovery. The current 10Y-2Y spread level is far below the levels at the start of previous recessions.
Investors can seize opportunities from normalization in the 10Y-2Y spread using CME Yield futures. The CME Yield futures are quoted directly in yield with a one basis point change in the yield representing a P&L of USD 10.
The below hypothetical trade setup consisting of long 10Y yield futures and short 2Y yield futures expresses a view on the further steepening of the yield spread with a reward to risk ratio of 1.3x.
Entry: 3.7
Target: 27.8
Stop Loss: -15
Profit at Target: USD 241 ( (27.8 – 3.7) x 10 = 24.1 x 10)
Loss at Stop: USD 187 ( (-15 – 3.7) x 10 = -18.7 x 10)
Reward to Risk: 1.3x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
10-Year T-Note vs. 10-Year Yield Futures: Which One To Trade?Introduction:
The 10-Year T-Note Futures and 10-Year Yield Futures are two prominent instruments in the financial markets, offering traders unique opportunities to capitalize on interest rate movements. This video compares these two products, focusing on their key characteristics, liquidity, and the differences in point and tick values, ultimately helping you decide which one to trade.
Key Characteristics:
10-Year T-Note Futures represent a contract based on the value of U.S. Treasury notes with a 10-year maturity, while 10-Year Yield Futures are based on the yield of these notes. The T-Note Futures contract size is $100,000, while the 10-Year Yield Futures contract size is based on $1,000 per index point, reflecting a $10 DV01 (dollar value of a one basis point move).
Liquidity Comparison:
Both 10-Year T-Note Futures and 10-Year Yield Futures are highly liquid, with substantial daily trading volumes and open interest. This high liquidity ensures tight spreads and efficient trade execution, providing traders with confidence in entering and exiting positions in both markets.
Point and Tick Values:
Understanding the point and tick values is crucial for effective trading. For 10-Year T-Note Futures, each tick is 1/32nd of a point, worth $31.25 per contract. The 10-Year Yield Futures have a tick value of 0.001 percent, worth $1.00 per contract. These values influence trading costs and profit potential differently and are essential for precise strategy formulation.
Margin Information:
The initial margin requirement for 10-Year T-Note Futures typically ranges around $1,500 per contract, while the maintenance margin is slightly lower. For 10-Year Yield Futures, the initial margin is approximately $500 per contract, reflecting its lower notional value and DV01. Maintenance margins for yield futures are also marginally lower, providing traders with flexible capital management options.
Trade Execution:
We demonstrate planning and placing a bracket order for both products. Using TradingView charts, we set up entry and exit points, showcasing how the different tick values and liquidity levels impact trade execution and potential outcomes.
Risk Management:
Effective risk management is vital when trading futures. Utilizing stop-loss orders and hedging techniques can mitigate potential losses. Avoiding undefined risk exposure and ensuring precise entries and exits help maintain a balanced risk-reward ratio, which is essential for long-term trading success.
Conclusion:
Both 10-Year T-Note Futures and 10-Year Yield Futures offer unique advantages. The choice depends on your trading strategy, risk tolerance, and market outlook. Watch the full video for a detailed analysis and insights on leveraging these products in your trading endeavors.
When charting futures, the data provided could be delayed. Traders working with the ticker symbols discussed in this idea may prefer to use CME Group real-time data plan on TradingView: www.tradingview.com This consideration is particularly important for shorter-term traders, whereas it may be less critical for those focused on longer-term trading strategies.
General Disclaimer:
The trade ideas presented herein are solely for illustrative purposes forming a part of a case study intended to demonstrate key principles in risk management within the context of the specific market scenarios discussed. These ideas are not to be interpreted as investment recommendations or financial advice. They do not endorse or promote any specific trading strategies, financial products, or services. The information provided is based on data believed to be reliable; however, its accuracy or completeness cannot be guaranteed. Trading in financial markets involves risks, including the potential loss of principal. Each individual should conduct their own research and consult with professional financial advisors before making any investment decisions. The author or publisher of this content bears no responsibility for any actions taken based on the information provided or for any resultant financial or other losses.
Navigating Interest Rates with Micro Yield Futures Pair TradingIntroduction to Yield Futures
In the complex world of financial markets, Treasury Yield Futures offer investors a pathway to be exposed to changes in U.S. treasury yields. Among these instruments, the Micro 10-Year and Micro 2-Year Yield Futures stand out due to their granularity and accessibility. These futures contracts reflect the market's expectations for the yields of U.S. Treasury securities with corresponding maturities.
Micro 10-Year Yield Futures allow traders to express views on the longer end of the yield curve, typically influenced by factors like economic growth expectations and inflation. Conversely, Micro 2-Year Yield Futures are more sensitive to changes in the federal funds rate, making them a ideal for short-term interest rate movements.
Why Pair Trading?
Pair trading is a market-neutral strategy that involves taking offsetting positions in two closely related securities. This approach aims to capitalize on the relative price movements between the two assets, focusing on their correlation and co-integration rather than their individual price paths. In the context of Micro Treasury Yield Futures, pair trading between the 10-Year and 2-Year contracts offers a strategic advantage by exploiting the yield curve dynamics.
By simultaneously going long on Micro 10-Year Yield Futures and short on Micro 2-Year Yield Futures (or vice versa), traders can hedge against general interest rate movements while potentially profiting from changes in the yield spread between these maturities.
Analyzing the Current Market Conditions
Understanding the current market conditions is pivotal for executing a successful pair trading strategy with Micro 10-Year and Micro 2-Year Yield Futures. Currently, the interest rate environment is influenced by a complex interplay of economic recovery signals, inflation expectations, and central bank policies.
Central Bank Policies: The Federal Reserve's stance on interest rates directly affects the yield of U.S. Treasury securities. For instance, a hawkish outlook, suggesting rate hikes, can cause short-term yields to increase rapidly. Long-term yields might also rise but could be tempered by long-term inflation control measures.
Strategic Approach to Pair Trading These Futures
Trade Execution and Monitoring
To effectively implement a pair trading strategy with Micro 10-Year and Micro 2-Year Yield Futures, traders must have a solid plan for identifying entry and exit points, managing the positions, and understanding the mechanics of yield spreads. Here’s a step-by-step approach:
1. Identifying the Trade Setup
Mean Reversion Concept: In this strategy, we utilize the concept of mean reversion, which suggests that the yield spread will revert to its historical average over time. To quantify the mean, we employ a 20-period Simple Moving Average (SMA) of the spread between the Micro 10-Year and Micro 2-Year Yield Futures. This moving average serves as a benchmark to determine when the spread is significantly deviating from its typical range.
Signal Identification using the Commodity Channel Index (CCI): To further refine our entry and exit signals, the Commodity Channel Index (CCI) is employed. The CCI helps in identifying cyclical turns in the spread. This indicator is particularly useful for determining when the spread has reached a condition that is statistically overbought or oversold.
2. Trade Execution:
Going Long on One and Short on the Other: Depending on your analysis, you might go long on the Micro 10-Year Yield Futures if you anticipate the long-term rates will increase more relative to the short-term rates, or vice versa.
Position Sizing: Determine the size of each position based on the volatility of the yield spreads and your risk tolerance. It's crucial to balance the positions to ensure that the trade remains market-neutral.
Regular Review and adjustments: Regularly review the economic indicators and Fed announcements that could affect interest rates. Keep an eye on the spread for any signs that it might be moving back towards its mean or breaking out in a new trend.
Contract Specifications
To further refine our strategy, understanding the specific contract details of Micro 10-Year and Micro 2-Year Yield Futures is crucial:
Micro 10-Year Yield Futures (Symbol: 10Y1!) and Micro 2-Year Yield Futures (Symbol: 2YY1!):
Tick Value: Each tick (0.001) of movement is worth $1 per contract.
Trading Hours: Sunday to Friday, 6:00 p.m. to 5:00 p.m. (New York time) with a 60-minute break each day beginning at 5:00 p.m.
Initial Margin: Approximately $350 per contract, subject to change based on market volatility.
Pair Margin Efficiency
When trading Micro 10-Year and Micro 2-Year Yield Futures as a pair, traders can leverage margin efficiencies from reduced portfolio risk. These efficiencies lower the required capital and mitigate volatility impacts.
The two charts below illustrate the volatility contrast: the Daily ATR of the yield spread is 0.033, significantly lower than the 0.082 ATR of the Micro 10-Year alone, nearly three times higher. This lower spread volatility underlines a core advantage of pair trading—reduced market exposure and potentially smoother, more predictable returns.
Risk Management in Pair Trading Micro Yield Futures
Effective risk management is the cornerstone of any successful trading strategy, especially in pair trading where the goal is to mitigate market risks through balancing positions. Here are key risk management techniques that should be considered when pair trading Micro 10-Year and Micro 2-Year Yield Futures:
1. Setting Stop-Loss Orders:
Pre-determined Levels: Establish stop-loss levels at the outset of the trade based on historical volatility, maximum acceptable loss, and the distance from your entry point. This helps in limiting potential losses if the market moves unfavorably.
Trailing Stops: Consider using trailing stop-loss orders that move with the market price. This method locks in profits while providing protection against reversal trends.
2. Position Sizing and Leverage Control:
Balanced Exposure: Ensure that the sizes of the long and short positions are balanced to maintain a market-neutral stance. This helps in minimizing the impact of broad market movements on the pair trade.
Leverage Management: Be cautious with the use of leverage. Excessive leverage can amplify losses, especially in volatile market conditions. Always align leverage with your risk tolerance and market assessment.
3. Regular Monitoring and Adjustments:
Adaptation to Market Changes: Be flexible to adjust or close the positions based on significant changes in market conditions or when the initial trading assumptions no longer hold true.
4. Utilizing Risk Management Tools:
Risk Management Software: Set alerts on TradingView to help track the performance and risk level of your pair trades effectively.
Backtesting: Regularly backtest the strategy against historical data to ensure it remains effective under various market conditions. This can also help refine the entry and exit criteria to better handle market volatility.
Effective risk management not only preserves capital but also enhances the potential for profitability by maintaining disciplined trading practices. These strategies ensure that traders can sustain their operations and capitalize on opportunities without facing disproportionate risks.
Conclusion
Pair trading Micro 10-Year and Micro 2-Year Yield Futures offers traders a sophisticated strategy to exploit inefficiencies within the yield curve while mitigating exposure to broader market movements. This approach leverages the distinct characteristics of these two futures contracts, aiming to profit from the relative movements between long-term and short-term interest rates.
Key Takeaways:
Market Neutral Strategy: Pair trading is fundamentally a market-neutral strategy that focuses on the relative performance of two assets rather than their individual price movements. This can provide insulation against market volatility and reduce directional risk.
Importance of Strategy and Discipline: Successful pair trading requires a disciplined approach to strategy implementation, from trade setup and execution to ongoing management and exit. Adhering to a predefined strategy helps maintain focus and objectivity in trading decisions.
Dynamic Market Adaptation: The financial markets are continuously evolving, influenced by economic data, policy changes, and global events. A successful pair trader must remain adaptable, continuously analyzing market conditions and adjusting strategies as needed to align with the current economic landscape.
Comprehensive Risk Management: Effective risk management is crucial in pair trading, involving careful consideration of position sizing, stop-loss settings, and regular strategy reviews. This ensures sustainability and longevity in trading by protecting against undue losses.
By maintaining a disciplined approach and adapting to market changes, traders can harness the potential of Micro Treasury Yield Futures for strategic pair trading, balancing risk and reward effectively.
When charting futures, the data provided could be delayed. Traders working with the ticker symbols discussed in this idea may prefer to use CME Group real-time data plan on TradingView: www.tradingview.com This consideration is particularly important for shorter-term traders, whereas it may be less critical for those focused on longer-term trading strategies.
General Disclaimer:
The trade ideas presented herein are solely for illustrative purposes forming a part of a case study intended to demonstrate key principles in risk management within the context of the specific market scenarios discussed. These ideas are not to be interpreted as investment recommendations or financial advice. They do not endorse or promote any specific trading strategies, financial products, or services. The information provided is based on data believed to be reliable; however, its accuracy or completeness cannot be guaranteed. Trading in financial markets involves risks, including the potential loss of principal. Each individual should conduct their own research and consult with professional financial advisors before making any investment decisions. The author or publisher of this content bears no responsibility for any actions taken based on the information provided or for any resultant financial or other losses.
Long 10Y, Short 2Y on Yield Curve NormalisationWorld's most important and the largest financial market is the US Treasury. Annual issuance of U.S. Treasuries has exploded. A record USD 23 trillion of treasuries were issued in 2023.
This market is experiencing gradual but notable shifts due to the Federal Reserve (Fed) recent tapering of quantitative tightening and the Treasury buyback. Collective impact has led to demand divergence across different maturities.
The yield curve starting to normalize once more. Economic outlook impacts the yield curve. Not only that, the Fed’s quantitative tightening (“QT”) campaign also has an enormous influence.
At its most recent FOMC meeting, Chair Jerome Powell stated that the Fed would start to slow its balance sheet runoff. The runoff results in supply contraction enabling greater demand for long-term treasuries and a subsequent yield curve normalization.
Runoff refers to the reduction in Fed’s balance sheet as they opt to let their treasury holdings mature without renewing them. This activity leads to a supply contraction.
RECENT HAWKISH FED MEETING CAME WITH A CAVEAT
Since 2022, the Fed has been engaged in a QT campaign. Raising rates is its primary tool. Balance Sheet reduction is an additional strategy to manage monetary environment.
The Fed first announced that it would start to reduce holdings of US treasuries at a fixed pace at its May 2022 meeting. The pace of reduction accelerated as Fed stepped up QT. Treasury runoff has continued at a fixed pace since then.
At the April FOMC meeting, Fed announced its decision to slowdown the runoff. In other words, Fed would start to let treasuries to mature at a slower pace.
Starting from the first of June, the Fed will decrease the maximum amount of treasuries that can mature without being replaced from USD 60 billion per month to USD 25 billion.
Fed’s outlook on rate cuts was hawkish. But its resolve to taper runoff is dovish signalling the Fed’s end of QT campaign through balance sheet reduction. Treasury runoff tapering impact will be noticed additional liquidity before rate cuts arrive.
HOLDINGS & RUN-OFF IS AIMED AT LONG-TERM TREASURIES
Fed’s QT via treasury holdings is implemented through the non-renewal of existing holdings.
Crucially, the impact of letting treasuries mature is more pronounced on long-term treasuries than short term ones. As short-term treasuries mature more often, the impact of this run-off on near-term treasury demand is limited.
In contrast, the impact on long-dated expiries is more pronounced. Analysing the cumulative run-off since May 2022, the largest impact on long-term treasuries has been on 5 to 10 years category which consists primarily of 10-Year notes. This run-off has been particularly high over the last few months. On the contrary, the holdings of 10+ year treasuries have increased.
Source – Federal Reserve
TAPERING RUNOFF SUGGESTS IMPROVEMENT IN LONG-TERM TREASURY DEMAND
Impact on benchmark 10-Year treasuries will be most pronounced as the Fed moves to slow the pace of its runoff. Longer maturities have lagged near-term ones at recent auctions. It was most apparent at the latest auctions.
The 10-Year treasury auction raised USD 42B, that is far higher than the average over the last twelve auctions at USD 31B. While the bid-to-cover was higher than the previous auction in April, it was below the average over the last twelve auctions. Indirect bidding was below average at 65.5%. Overall, this suggests an unimpressive result.
In sharp contrast, 3-Year treasury auction showed strong demand. It raised USD 58B, the highest since 2021. Bid-to-cover was higher than the last auction. Non-dealer bidding was also above average at 85.1% (81.7% average). Similarly, the Treasury 5-Year auction raised USD 70B with an above average non-dealer bidding. Both 3-Year and 5-Year auction results were much stronger.
As observed through the CME TreasuryWatch Tool , the demand for 2-year treasuries has been noticeably higher, as suggested by the bid-to-cover ratios, compared to 10-year and 30-year treasuries.
Source – CME TreasuryWatch
FED’S TAPERING TO FUEL 10Y SPREAD TO OUTPERFORM 5Y SPREAD
Yield curve is normalizing once more following the decline in the 10Y-2Y spread at the start of 2024. This trend is likely to continue as yields for longer dated maturities rise higher than near-term maturities.
Mint Finance highlighted previously that the 5Y-2Y spread is likely to outperform the 10Y-2Y spread. However, as Fed starts to taper its balance sheet run-off, the impact is likely to be felt strongest at the 10Y maturity allowing demand for these treasuries to rise once more.
HYPOTHETICAL TRADE SETUP
Fed’s balance sheet runoff slowdown and the underperformance of the 10Y-2Y spread relative to the 5Y-2Y spread, the 10Y-2Y spread has potential outperform in the near term as the yield curve turns to normalcy.
To harness gains from this normalization, investors can opt to execute a spread trade consisting of Yield futures.
CME Yield futures are quoted directly in yield with a one basis point change in the yield representing a P&L of USD 10. As yield futures across various maturities represent the same notional, spread P&L calculations are equally intuitive with a one basis point change in the spread between two separate maturities also adding up to a P&L of USD 10.
• Entry: -32.3 basis points
• Target: -28.3 basis points
• Stop Loss: -35.3 basis points
• Profit at Target: USD 400
• Loss at Stop: USD 300
• Reward to Risk: 1.3x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Is this the top for the 10 year yield?We have observed interesting price action in the 10-year yield, most noticeably the double top that has emerged within the 425-435bps range. On the heels of the Fed sticking to 75 basis points worth of cuts in the most recent interest rate projection, this could be the top in yields in 2024.
Key Developments:
Recent releases of Feb CPI and PPI were hotter than consensus estimates, which made many doubt the fact that the FOMC would stick to its guidance of three 25 basis point cuts in 2024. However, Fed Chair Powell and Committee members seemed to have a new tone, one that did not want to sacrifice the growth of the economy, even though some metrics of inflation show stickiness.
The markets were closed in observance of Good Friday, however, Core PCE and PCE (the Fed’s preferred inflation indicator) were still released. This number came in at 2.8% YoY in line with consensus estimates, however, the January release was revised higher from 2.8% to 2.9% YoY.
Overall, this was a decent inflation report, as consumer spending still showed strength, while personal income grew slightly less than expected. Recent Michigan Consumer Sentiment came in higher than expected, while one- and five-year inflation expectations came down slightly, reflecting consumers’ confidence in inflation returning to a more normalized target.
Technicals:
As the FOMC has stuck to 75 bps worth of cuts, it does seem that this would put a cap on short-term yields, as well as the 10-year. Provided inflation does not meaningfully reaccelerate, major overhead resistance will come in at 430 - 435bps. Should there be a break and close above this level, we could see the 10-year yield regain momentum, working its way up to 450bps.
Check out CME Group real-time data plans available on TradingView here: www.tradingview.com
Disclaimers:
CME Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
Futures trading involves substantial risk of loss and may not be suitable for all investors. Trading advice is based on information taken from trade and statistical services and other sources Blue Line Futures, LLC believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder. Past performance is not necessarily indicative of future results.
How low can note interest go?The 10-year Treasury note interest derivative contract has been ticking down for a few weeks. We expect to see it bottom out well below 4%. Our inclination is to go short on a close below 4.1.
What Next For The Inverted Yield Curve?Markets are notorious for exaggerated expectations. They sense a tiger when all they see is a cat. Expectations on rate cuts have been no different. Despite the Fed’s speak on measured changes to policy rates, markets got ahead of themselves since late last year. Markets are now starting to align their expectations with reality.
US economic data from January stands in stark contrast to December readings. Nonfarm payrolls and CPI are higher than expectations. A resilient economy and rebound in inflation have pushed expectations of rate cuts to much later this year.
According to the CME Group FedWatch tool, the probability of a rate cut at the March FOMC policy meeting dropped from 73% on 29 Dec 2023 to merely 8.5% as of 19 Feb 2024. First rate cut is now expected at the 12 June policy meeting this year. Markets are now pricing four rate cuts instead of six cuts as previously anticipated.
Shift in rate cut expectations has led to a rebound in US treasury bond yields. This paper delves into the factors behind the shift in rate expectations. The paper also analyses a hypothetical trade setup using CME Group Yield futures that investors can deploy to harness gains from revised policy path ahead.
RATE CUT EXPECTATIONS IS BECOMING MORE ROOTED IN REALITY NOW
A stream of recent economic data from the US has pointed to a stronger economy and a rebound in inflation, causing rate cut expectations to shift.
January nonfarm payrolls report showed 353k jobs added, exceeding expectations of 333k and the largest build since January 2023. January CPI report showed annual CPI growth slow from its pace of 3.4% in December 2023 to 3.1% in Jan 2024 but still hotter than analyst expectations of 2.9%.
Core CPI was another concern as it stood unchanged at 3.9%. On a monthly basis, CPI jumped 0.3% MoM. 0.6% MoM increase in rent prices and 0.4% increase in food prices were behind the monthly increase.
On the positive front, PPI fell 0.1% MoM in January, with goods prices 0.4% lower. PPI is just 1% higher YoY against an estimate of +1.3% estimate.
January Retail Sales fell sharply by 0.8% MoM in January. December growth was revised lower from +0.6% to +0.4%. This is expected to lead to a lower GDP growth in Q1. GDPNow model from the Atlanta Fed predicts 2.9% growth in Q1, compared to 3.4% before the release.
As a result of the broadly stronger data and higher inflation, expectations of rate cuts at the 20/March FOMC meeting have fallen from their peak of 74% on 29 December 2023 to 8.5% as of 19 February 2024. Expectations for a rate cut by May have also been scaled back. As of 14 Feb 2024, there is just 35% probability of a rate cut at the 01 May FOMC meeting as well.
Source: CME Group FedWatch
FedWatch indicates 50% probability of a rate cut for the meeting on 12 June 2024, which is up from 40% a week ago.
Source: CME Group FedWatch
The increase reflects the recent retail sales and jobless claims data that was stronger than expected. Both have led to a pullback in bond yields from their 2024 highs.
Source: CME Group FedWatch
The CME Group FedWatch tool indicates expectations of four rate cuts in 2024 as of 18/Feb down from six cuts at the start of the year.
The expectations around rate cuts have also shifted in Fed’s messaging. Atlanta Fed President Raphael Bostic stated that the Federal reserve does not face any urgency in cutting rates due to the current strength in the US economy. Dallas Fed President, Lorie Logan, shares similar sentiments .
Fed Chair Powell echoed the same message. Powell stated the Fed won’t cut rates until it has greater confidence that inflation is moving sustainably to its target. Specifically, he mentioned that a rate cut was unlikely by March. In an interview with “60 Minutes”, Powell suggested that Fed’s base case scenario of 75 basis points of rate cuts in 2024 was unchanged.
As a result of delayed rate cuts expectations, US treasury yields have rebounded.
FOMC MINUTES TO REITERATE HAWKISH POSTURE
Strong economic data and inflation numbers coming in hotter than expected will keep the Fed hawkish in the near term. How long will be anybody's guess?
On 21/Feb (Wed), minutes of the FOMC January meeting will be published. Expectations are for Fed to reiterate its hawkish posture. In anticipation, the 2-year yield futures are up forty-nine basis points (bps) to close at 4.601% as of 16/Feb (compared to 4.112% close of markets on 1/Feb).
Meanwhile, during the same period, the 10-year yield futures jumped forty-five bps to close at 4.295% as of close of markets on 16/Feb.
Taking directional views on the 2-year or the 10-year yields can be difficult when rate expectations are already baked into the yields. Directional views expose the trade to large downside risks vastly reducing reward-to-risk ratio.
In sharp contrast, spread trades enables trades to lock in gains while minimizing downside risks. This paper illustrates a hypothetical treasury spread trade below.
HYPOTHETICAL 10Y-2Y TREASURY SPREAD TRADE
Portfolio managers can better harvest gains from rate moves by trading the closely monitored US Treasury yield spread measuring the gap between yields on 2-year & 10-year Treasury notes. FOMC minutes reiterating a hawkish posture will invert the yield curve even more.
To help traders monitor this spread, the CME Group publishes a Micro Treasury CurveWatch tool which shows daily, weekly, and monthly changes in yields and major yield spreads.
Source: Micro Treasury CurveWatch tool
Portfolio managers can express this view by taking a short position in the CME Group 10-Year Yield Futures (10YG4) and a long position in the CME Group 2-Year Yield Futures (2YYG4).
● Entry: -0.2790 (27.9 bps; enter the spread trade when 10YG4 minus 2YYG4 is -0.2790 bps)
● Target Exit: -0.3690 (36.9 bps)
● Stop Loss: -0.2250 (22.5 bps)
● Profit at Target: USD 90 (9 bps x USD 10)
● Loss at Stop: USD 54 (5.4 bps x USD 10)
● Reward to Risk: 1.66x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
😳 TREASURY-BONDS COLLAPSE IS JUST ONE STEP AWAY TO COME BACKThe collapse in Treasury bonds in 2021-2023 now ranked among the worst market crashes in history.
Since March 2020 to 2023 fall, Treasury long term bonds with maturities of 10 years or more have plummeted over 40% while the 30-year bond had plunged over 50%.
That's just under losses seen in the stock market when the dot-com bubble burst.
The bond rout was worse than the one seen in 1981 when the 10-year yield neared 16%.
The bond-market sell-off that's sending yields soaring is starting to eclipse again some of the most extreme market meltdowns of past eras.
Those losses are nearly in line with stock-market losses seen during the worst crashes of recent history — when equities slumped 49% after the dot-com bubble burst and 57% in the aftermath of 2008.
Compared with previous bond-market meltdowns, long-term Treasurys are seeing one of the most extreme undoings in history. The losses are over twice as big as those seen in 1981 when 10-year yields neared 16%.
That crash came as the former Federal Reserve chair Paul Volcker grappled with historic inflation and pushed the federal funds rate to just under 20%.
While interest rates remain well below that level today, the central bank's aggressive turn toward monetary tightening in the post-pandemic era has caused a similar bond-market rout. And some traders have continued selling amid concerns of rebounding inflation, while a deluge of Treasury issuance this year has also pressured bond prices.
Technical graph for 10-year yield futures CBOT_MINI:10Y1! indicates that 52-weeks SMA support is still important for further T-Bonds pressure, while 10-year yield (unfortunately to T-Bonds holders) is still following major upside trendlines.
Market is Sensitive to what Jerome Powell is SayingAt the latest FOMC meeting on January 31st, Jerome Powell stated, 'The Fed is not ready to start cutting,' which immediately caused the yield to pivot higher. During an recent interview on Sunday, February 4th, he reiterated that the US central bank is not yet prepared to cut interest rates, resulting in another increase in the yield.
Today, we will discuss the direction of the yield or interest rates in the coming months, as well as why the Fed is carefully considering its decision to cut rates this time.
My name is Kon How, my work in this channel, as always, is to study behavioral science in finance, discover correlations between different markets, and uncover potential opportunities.
Micro 10-Year Yield Futures
Ticker: 10Y
0.001 Index points (1/10th basis point per annum) = $1.00
Disclaimer:
• What presented here is not a recommendation, please consult your licensed broker.
• Our mission is to create lateral thinking skills for every investor and trader, knowing when to take a calculated risk with market uncertainty and a bolder risk when opportunity arises.
CME Real-time Market Data help identify trading set-ups in real-time and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
Interest Rates Trading and Hedging Through a New LensIntroduction
In the dynamic world of financial markets, Micro 10-Year Yield Futures stand out as a pivotal tool for traders and investors. These futures offer unique opportunities to navigate the complexities of interest rates, particularly in an environment influenced by key economic indicators. This article delves into how traders can leverage both fundamental economic data and a novel technical analysis approach to optimize their strategies in trading and hedging with these futures.
Fundamental Analysis Approach
Understanding CPI, PPI, and Unemployment Rate:
Consumer Price Index (CPI): This indicator measures the average change over time in the prices paid by consumers for a basket of goods and services. It's a critical gauge of inflation, directly impacting interest rates and, consequently, the yields on Treasury securities.
Producer Price Index (PPI): PPI tracks the average change over time in the selling prices received by domestic producers for their output. It's a leading indicator of consumer inflation when producers pass on higher costs to consumers.
Unemployment Rate: This key metric reflects the number of unemployed workers as a percentage of the labor force. It’s vital for assessing the health of the economy, influencing monetary policy and interest rates.
These indicators, notably their changes, provide crucial insights for active trading, particularly in hedging strategies with Micro 10-Year Yield Futures. For instance, a higher-than-expected CPI or PPI might signal rising inflation, prompting traders to anticipate rate hikes and adjust their positions accordingly.
How to incorporate Fundamental Analysis into the trade decision process?
When making trading decisions for Micro 10-Year Yield Futures, it's crucial to understand the impact of economic reports on interest rates:
Buying (Long) Position Rationale:
When CPI, PPI, and Employment Rate (opposite of unemployment) are all increasing (indicated by green color on the chart), it typically suggests an expanding economy and potential inflationary pressures.
In such scenarios, interest rates are likely to rise to manage inflation. Hence, buying 10-Year Yield Futures could become a strategic move, anticipating a potential uptick in yields.
Selling Existing Long Positions:
A decrease in any of these indicators (CPI, PPI, Employment Rate) signals a potential slowdown or less aggressive inflationary pressure.
Traders holding long positions might consider selling to lock in profits or prevent losses, anticipating a potential drop in yields.
Selling (Short) Position Rationale:
If these reports show a decreasing trend (indicated by red color on the chart), it suggests economic contraction or reduced inflationary pressure.
Lower interest rates are often introduced to stimulate economic growth in such conditions. Shorting 10-Year Yield Futures could be advantageous as it would benefit from a potential fall in yields.
Buying Existing Short Positions:
An increase in any of these indicators (CPI, PPI, Employment Rate) signals a potential expanding economy and potential inflationary pressures.
Traders holding short positions might consider buying to lock in profits or prevent losses, anticipating a potential rise in yields.
Rationale Behind the Rules:
These rules are based on the traditional economic relationship between inflation, economic activity, and interest rates.
Rising inflation or strong economic growth (indicated by higher CPI, PPI, and Employment Rates) often leads to higher interest rates to prevent the economy from overheating.
Conversely, decreasing indicators suggest an economy that might need stimulation, often leading to lower interest rates.
By aligning trading strategies with these fundamental economic principles, traders can make more informed decisions, leveraging economic trends to speculate or hedge effectively.
Technical Analysis Approach
Yield Extremes and Curve Analysis:
This approach involves charting and combining the 2-Year and 30-Year yield futures contracts in one chart.
Analyzing the relationship between these yields provides insights similar to traditional yield curve analysis in a much more accessible format.
Key Indicator: A crossover between the 2-Year and 30-Year rates signifies a substantial shift in market sentiment and economic outlook.
How to Incorporate Technical Analysis into the Trade Decision Process?
As said, the crossover of yield rates between the 2-year and the 30-year yields is a pivotal event, suggesting significant changes in the yield curve. Here's how to interpret and act on these occurrences:
Identifying the Crossover Event:
A crossover event occurs when the 2-year yield rate overtakes the 30-year rate, or vice versa.
This event is indicative of a significant change in the interest rate environment, reflecting shifts in economic expectations and monetary policy.
Trading Strategy Based on Micro 10-Year Prior Price Action:
When the crossover occurs, the immediate strategy depends on the recent trend in the Micro 10-Year Yield Futures prices.
If the Micro 10-Year Yield was trending upwards prior to the crossover, it suggests bullish sentiment in the shorter term. In this scenario, traders could consider taking a short position, anticipating a potential reversal or bearish shift in the market.
Conversely, if the Micro 10-Year Yield was trending downwards, indicating bearish sentiment, traders could consider a long position post-crossover, capitalizing on the potential for a bullish reversal or recovery in prices.
Rationale Behind the Trade Rules:
The crossover event between the 2-Year and 30-Year yields represents a pivotal shift in market dynamics, often reflecting changes in economic policy, inflation expectations, or investor sentiment.
Prior price action in the Micro 10-Year Yield Futures provides a context for these shifts, indicating the market's prevailing trend and sentiment.
By aligning trading actions with both the yield curve dynamics (crossover event) and the recent trend of the Micro 10-Year Futures, traders can make informed decisions, leveraging the market's anticipated reaction to these significant economic indicators.
Market Outlook and Trade Plan
Keeping in mind the below tick and (Average True Range) ATR values, based on our analysis, we could express our market views through the following hypothetical set-ups:
Trade Plan for the Fundamental Analysis Approach:
ENTRY: Wait for the next CPI, PPI and Employment Rate reports and consider executing a trade if all 3 reports are either positive (long) or negative (short).
STOP LOSS: Located 1 Monthly ATR away from the entry price
Trade Plan for the Technical Analysis Approach:
ENTRY: The crossover may confirm itself at the end of the day. Wait for such confirmation and consider executing a short trade once confirmed.
STOP LOSS: Located 1 Monthly ATR away from the entry price
Tick Value: 0.001 Index points (1/10th basis point per annum) = $1.00
Monthly ATR: The average volatility is measured as 0.509 at the time of this report
Trade Example: If the 2-Year yield rises above the 30-Year yield amid rising CPI, consider a short position anticipating rate hikes.
Reward-to-Risk Ratio: Calculate this ratio to ensure a balanced approach to potential gains versus losses.
Risk Management in Futures Trading
Effective risk management is paramount. Utilize stop-loss orders and consider hedging techniques to mitigate potential losses. Understand the significance of economic reports and yield curve shifts in making informed decisions.
Conclusion
Micro 10-Year Yield Futures offer a versatile platform for interest rate trading and hedging. By combining monthly economic updates with a unique yield curve analysis approach, traders can navigate these markets with greater confidence and strategic foresight.
When charting futures, the data provided could be delayed. Traders working with the ticker symbols discussed in this idea may prefer to use CME Group real-time data plan on TradingView: www.tradingview.com This consideration is particularly important for shorter-term traders, whereas it may be less critical for those focused on longer-term trading strategies.
Disclaimer: The trade ideas presented herein are solely for illustrative purposes forming a part of a case study intended to demonstrate key principles in risk management within the context of the specific market scenarios discussed. These ideas are not to be interpreted as investment recommendations or financial advice. They do not endorse or promote any specific trading strategies, financial products, or services. The information provided is based on data believed to be reliable; however, its accuracy or completeness cannot be guaranteed. Trading in financial markets involves risks, including the potential loss of principal. Each individual should conduct their own research and consult with professional financial advisors before making any investment decisions. The author or publisher of this content bears no responsibility for any actions taken based on the information provided or for any resultant financial or other losses.
Fed Policy Trajectory and Interest Rate OutlookCBOT: Micro 2-Year Yield ( CBOT_MINI:2YY1! ), Micro 10-Year Yield ( CBOT_MINI:10Y1! ) and Micro 30-Year Yield ( CBOT_MINI:30Y1! )
The latest US jobs report showed that employers added 216,000 jobs for December while the unemployment rate held at 3.7%, reported by the Bureau of Labor Statistics (BLS). That compared with respective market estimates of 170,000 and 3.8%.
On Thursday, the BLS will release December’s CPI data. The prevailing market expectation is 0.3% monthly increase for headline CPI, up from 0.1% in November.
The Federal Reserve sets monetary policy to support price stability and full employment. New data shows that the US economy is very resilient, and maybe slightly overheated with the upbeat job market.
After hiking interest rates 11 times and pausing for 2 times, the Fed now has a dilemma. “To cut, or Not to cut”, this is a trillion-dollar question.
In this 3rd installment of new year outlook for major asset classes, I will discuss what opportunities may lie ahead for bonds and interest rate derivatives.
FYI: The first writing was a year-end review for metal commodities – Gold, Copper, and Aluminum. If you haven’t read it yet, you may follow the link here:
The second writing was New Year outlook for US equities – the benchmark market indexes Dow, S&P 500 and Nasdaq 100.
2023: what’s the dominating market narrative?
Last year, the Fed raised interest rates four times for a total of 100 bps. This was a slower pace comparing to the year before, where we saw seven rates hikes and 400 bps in total.
To the surprise of most analysts, businesses continue to expand and hire new workers under tightened credit. Inflation could creep up with higher wages and a strong job market.
US stock market rose for most of the year, shaking off bad news along the way. Despite interest rates are 5% higher than two yeas ago, major market indexes reached all-time-high records last December. The S&P 500 gained 23.9% for the year, and the Nasdaq Composite more than doubled that at 53.9%.
2024 Outlook for US Interest Rates
Most investors agree that the Fed will cut rates in 2024. But the expectations for the timing and scope vary significantly.
According to CME Group’s FedWatch Tool, the first rate-cut could occur at the March 20th Fed meeting, with a 69.2% probability. For June 12th, the odds of two or more rate cuts increase to 85.9%. By December 18th, investors expect the Fed Funds rate to fall between 1% to 2% lower than the current 5.25-5.50% range, with a 97.9% odds (Data as of January 7th).
(Link: www.cmegroup.com)
Treasury prices and yields move in opposite directions. Current bond prices reflect the market expectations of 5-8 rate cuts in 2024. Lower yields, higher prices.
The January 2nd CFTC Commitments of Traders report (COT) shows that “Leveraged Funds” hold the following open positions on CBOT interest rate futures:
• Fed Funds: 224,772 longs and 489,204 shorts
• 2Y Treasury: 775,882 longs and 2,266,563 shorts
• 5Y Treasury: 844,600 longs and 2,821,682 shorts
• 10Y Treasury: 285,598 longs and 775,882 shorts
• 30Y Treasury: 79,124 longs and 497,636 shorts
The overwhelmingly Net short positions indicate that the “Smart Money” considers the rate cuts being oversold. Why do they want to short Treasury futures? If the Fed keeps the interest rates higher for longer, or implements fewer rate cuts, Treasury yields would be higher than the current price indicated. Higher yields, lower prices. Shorting Treasury futures expresses the viewpoint that Treasury bond prices would fall.
In my opinion, the bond market tends to tell a better story, compared to the stock market. The institutional nature of most participants allows the bond market to be less prone to irrational hypes and price bubbles.
Trading with CBOT Micro Yield Futures
Micro Treasury Yield Futures are low-cost instruments to participate in the bond market. Micro yields are quoted by treasury yield directly. Higher yields, higher futures prices. This would ease the burden from working the complicated price and yield conversion.
Last Friday, the February contract of Micro 2Y Yield futures (2YYG4) were settled at 4.186%. Each contract has a notional value of 1,000 index points, or $4,186 at current price. To acquire 1 contract, a trader is required to deposit an initial margin of $340.
The February Micro 10Y Yield (10YG4) was settled at 4.008%. Notional value is 1,000 index points or $4,008. Initial margin is $320.
The February Micro 30Y Yield (30YG4) was settled at 4.221%. N notional value is 1,000 index points or $4,221. Initial margin is $290.
My reasoning:
We just had a hotter than expected jobs report for December. If CPI data shows inflation rebound this week, the whole Fed cut narrative could be derailed. The January 30th Fed meeting could have a surprised rate decision, or a more hawkish Fed statement.
To replicate the short bond futures strategy used by Leveraged Funds, investors could long the micro yield futures to express the same view of higher yields. Initial margins for 10Y Micro Yield are $320, compared to $2,125 for 10Y treasury notes futures (ZN).
Hypothetically, if the yield goes up by 25 bps, a long Micro Yield futures position would gain $250 (= 0.25 x 1000). This would be the same for 2Y, 5Y, 10Y and 30Y micro yield futures, as they all have a 1,000-point multiplier.
On the other hand, if investors continue to ignore the Fed, as they have often been in the past two years, short futures will lose money.
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
Will the 10 Year Treasury Yield Break Out? Retail sales surge higher than expected on October 17th, Industrial Production comes in higher than expected, and Atlanta Fed GDP Now for Q3 was revised higher from 5.1% to 5.3%. With the economy and the consumer remaining resilient, is the 10 year primed to break out to new 52 week highs? Rates will continue to be dependent on economic data, and further resilience to higher yields is likely to lead to higher yields.
What's Next?
The 10 year yield has seen tremendous strength since breaking out above the 10/21/22 highs. We can see that as of late, the 10 year has traded within a parallel channel, which is roughly 35-40 basis points wide. Major resistance will be the previous highs on October 6th. This is defined in the chart as “Major Resistance.” If the 10 year can break and close above this level (4.88), the 10 year is likely to test the psychologically significant 5.00 handle.
Weaker than expected economic data or further escalating geopolitical conflict could provide a relief rally for treasuries, thus sending yields lower. As this 10 year yield contract is moving near a 45 degree angle, a faster moving average, like the 21 day EMA will provide for a better support level. Currently the 21 day EMA is at 4.61. A break and close below this level is likely to then test the parallel channel, where a break and close below the channel could neutralize this bullish trend.
Check out CME Group real-time data plans available on TradingView here: www.tradingview.com
Disclaimers:
CME Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
Futures trading involves substantial risk of loss and may not be suitable for all investors. Trading advice is based on information taken from trade and statistical services and other sources Blue Line Futures, LLC believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder. Past performance is not necessarily indicative of future results.
Navigating The Inverted Yield CurveThe US Government runs a large budget deficit which in turn has helped enrich several emerging markets by creating a massive market for their products and services.
These deficits are financed by issuance of treasuries. Given US’ global heft, treasuries are considered “risk-free” assets, held by institutions and other central banks as reserves.
Investors hold treasuries. Many participate in the liquid CME Treasury Futures market to hedge their debt portfolios against interest rate volatility while gaining exposure to change in yields.
Unprecedented steep rate hikes with expectations of higher for longer rates, the yield curve has reached inversion levels unseen in 42 years.
With near term rates set to spike even more, a long position in near term contract combined with a short position in longer maturity treasury futures, with an entry at -79.7 basis points (bps) and a target of -142.4 bps, and hedged by a stop loss at -35.6 bps, is likely to deliver a reward-to-risk ratio of 1.4x.
US’ PROFLIGATE BORROWING IS FINANCED BY TREASURIES
The US Government can afford to and has been a profligate borrower. It has run a deficit each year since 2001. In fact, it has had budget surplus only five (5) times in the last fifty (50) years, as mentioned in our previous paper .
The US Treasury Department finances the deficit by issuing Treasury Bills (< 1 year maturity), Notes (maturities between 2 to 10 years), & Bonds (more than 20-year maturities). These securities pay a fixed return and can be redeemed at face value at maturity.
FACTORS IMPACTING TREASURY RATES
Many factors influence treasury rates. Key among them is (a) Supply & Demand, (b) Fed Rates, (c) Economic growth rates, and (d) Inflation.
Supply and Demand
Two primary sources of supply. First, the US Government. The borrowing needs of the Government shapes the size of supply. All things being equal, increased supply pushes bond price lower and the yield higher.
When Fed sells, supply increases. When the Fed buys treasuries, it causes supply to shrink and thereby influences bond yields.
Fed Rates
Treasury rates are different from Fed rates. Fed rates have an enormous impact on Treasury rates. Fed rates function as the benchmark for all other interest rates including treasury rates. However, longer term rates are not just affected by the current rates but also by the future policy path.
Short term treasuries trade tightly in tandem with the benchmark Fed rates. The longer-term treasuries do not move in lockstep as they factor in future expectations.
The correlation between Fed rates and treasury rates across different short-term maturities breaks during periods of policy changes.
Economic Growth Rates
During periods of strong economic growth higher yielding corporate debt are more attractive to investors relative to Treasuries causing demand contraction for the latter.
Higher economic growth usually results in inflation prompting central banks to raise interest rates. Combined impact of this sends treasury yields higher.
Conversely, slow growth presses yield lower.
Inflation
High inflation typically warrants central bank intervention. These have a major impact on treasury yields. Inflation reduces the real returns of the treasuries prompting higher yields to compensate for inflation led erosion.
Inflation is a concern for longer term debt holders as the present value of future cash-flows are adversely affected.
These factors together drive changes in the yield and price of US treasuries having varied effect across different maturities which can be observed along the yield curve.
THE YIELD CURVE
The yield curve sheds light on future expectations of interest rates, growth, and inflation. Under normal conditions, the yield curve slopes upwards implying greater returns to compensate for higher risk from holding long-term debt including inflation led value erosion.
Presently, the yield curve exhibits steep backwardation (downward slope) indicating lenders need for higher risk compensation in the near-term relative to longer maturities.
This term structure is referred to as yield curve inversion. An inverted yield curve has in the past been a credible indicator of near-term recession expectations, and subsequent rate cuts.
Inverted yield curve, simply put, refers to the fact that the yield of US two-year Treasury Bonds is higher than that of of US ten-year treasury.
Yield curve inversion at the extremes presents opportunities for the astute investor. The CME Group’s Micro Treasury Futures enable investors to shrewdly participate in rate markets.
COMPREHENDING US INTEREST RATE DYNAMICS
In its most recent meeting, the US Fed paused rates hike. FOMC meeting minutes made it clear that Fed is not done with hiking.
Better-than-expected GDP reading and a resilient labour market create ample space for further rate hikes. The June FOMC meeting minutes show that 16 out of 18 Fed officials (89%) expect at least one more rate hike while 12 out of 18 (67%) expect two more hikes.
Meanwhile, CME’s Fedwatch tool shows an 89% probability of a rate hike in July with many anticipating another hike after that.
Because of unprecedented steepest rate hikes on record, the spread between the 2-Year & 10-Year Notes has inverted to levels unseen since 1981.
SIGNALS FROM COMMITMENT OF TRADERS (COT) REPORT
What’s next for US interest rates? The COT shows that institutional asset managers have been increasing their net long positioning in Treasury Futures since the start of Fed rate hiking cycle while leveraged funds (hedge funds) have been increasing their net short positioning.
Over the last few weeks, positioning in shorter maturity bonds have continued to trend similarly while a plateau is observed in the longer-maturity futures indicating that the yield for long-duration bonds may not rise much higher.
Overall, institutional investors are still expecting rates to go higher this year but also positioning for the spread between short and long-duration yields to widen further.
OPTIONS MARKET SENTIMENTS
US 2Y Treasury Note options have a put call ratio of 0.76 while US 10Y Note options have a put call ratio of 0.86.
Both indicate more calls than puts, expecting bond prices to rise and yield to fall. Notably, the put/call ratio is far lower for August expiries than September expiries.
CME MICRO TREASURY FUTURES PRODUCT SUITE
The CME Group offers a wide range of products. According to Trading View statistics, CME’s rates & treasury bond derivatives trade a daily notional of USD 5.6 trillion and 7.5 million lots.
Based on notional values, the bond derivatives market is 6x larger than equity index derivatives and 45x larger than energy derivatives market.
Micro Treasury Futures are more intuitive as they are quoted in yields and are cash settled. Each basis point change in yield represents a USD 10 change in notional value.
These products reference yields of on-the-run treasuries and settled daily to BrokerTec US Treasury benchmarks ensuring price integrity and consistency.
Micro Treasury Futures are available for 2Y, 5Y, 10Y, and 30Y maturities enabling traders to take positions across the yield curve.
TRADE SET UP
With rates expected to go higher, even at the risk of economic disruption, the yield curve is expected to invert even more. To express this view, investors can use CME’s Micro Treasury Futures.
A long position in the Micro 2-Year yield futures would benefit from higher rates while a short position in the Micro 10-Year yield futures would benefit from the increasing risks of economic slowdown caused by higher rates for longer.
With near term rates set to spike, a long position in near term contract combined with a short position in longer maturity treasury futures, with an entry at -79.7 basis points (bps) with a target of -142.4 bps, and hedged by a stop at -35.6 bps, is likely to deliver a reward-to-risk ratio of 1.4x.
• Entry Level: -0.797 (-79.7 bps)
• Stop Level: -0.356 (-35.6 bps)
• Target Level: -1.424 (-142.4 bps)
• Loss at Stop: USD 441
• Profit at Target: USD 627
• Reward/Risk: 1.4x
Micro Treasury Futures provide margin offsets for spreads. For this spread, a margin offset of 50% is available which makes the total margin requirement for this position 50% x (USD 370 + USD 320) = USD 345.
These micro contracts simplify the spread trade P&L arithmetic as all contracts are of the same size. The spread value can be used to directly to compute the P&L. Every one basis point move in the spread represents a P&L change of USD 10.
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
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Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
