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2s vs 10s


Discussion in Treasury Notes and Bonds

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2s vs 10s

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  #1 (permalink)
 SMCJB 
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2 year treasury yields are currently 40 bp's over 10 year treasury yields a level not seen since the global financial crisis.

Anybody have any thoughts or suggestions on how to trade the reversion?

You could spread the Micro Yield Contracts 2YY - 10Y which would be very clean and even has an exchange listed spread. Biggest problem I see with this is you would have to trade the Sep contract and roll it every month. Current cost to roll to October is 3.7 bps (exclusive of fees).

You could also spread ZT (2 year) and ZN (10 year) but these are both quoted in price and not yield which makes it dirtier as you know need to start thinking about DV01 etc. There is also a CME ZT-ZN spread which trades at a ratio of 2:1.

FYI I'm currently long (and so far wrong (but not terribly)) ZN, so in reality I'm thinking more about rolling my ZN to ZT but that is the same as trading the spread.


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 Schnook 
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I played around with the micro yield contracts a while back and found them to be costly and inefficient. Poor liquidity, high transaction costs, and monthly rolls just end up taking way too much out of my positions. So I still prefer using the regular treasury futures for yield spreads.

Regarding the spread ratios, I built a simple spreadsheet using DV01 data straight from the CME website (link: https://www.cmegroup.com/tools-information/quikstrike/treasury-analytics.html)




The regular ZN 10yr is more like a 7yr due to its broad eligibility for deliverables, so you'll get a much cleaner 2s/10s expression by using the TN ultra 10yr.

You're obviously correct that the ratio will drift over time but I try not to get too hung up on accuracy simply because things tend to get a bit squirrely anyway and I just end up chasing my tail.

If I were looking to put on a 2s 10s steepener here I'd be looking at a bear steepener, that is, long end yields moving higher as opposed to (or more than) short end yields moving lower. This, being a bearish expression, implies you'd prefer to be net short DV01 rather than net long when all is said and done. The actual DV01 ratio of 1.91 (66.37 for ZN vs 34.77 for ZT) leaves you slightly net long duration if you buy 2 ZTs against every ZN you sell, so that works against you just a little bit. But it's such a small residual amount that it shouldn't hurt you too much. You can even view it as a partial hedge

If using TN, the ratio is closer to 2.8 so you can buy 3 ZT for every TN you buy and again be left slightly net long, or you can go 5:2 or 11:4 and be net short a few dollars per bp.

And for what it's worth I don't mind this trade right now. I think aggressive rate hikes are pretty well priced in to the front end (note the very large net spec shorts in ZT, ZF, and eurodollars per COT), but the long end is vulnerable to supply issues amid heavy net issuance, mortgage convexity hedging (duration of the mortgage market extending meaningfully as rates rise and refis / prepayments grind to a halt), and QT ramping up. Monday's sloppy 10yr auction gave a good hint as to what may come.

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 SMCJB 
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Hey @Schnook, Thank You for your excellent post.

Agree the newer micro's are all expensive to trade but maybe good to learn with. Also I they do allow people with smaller accounts to trade products they wouldn't otherwise although some of them help more than others. (eg Silver SI|SIL is 1:5 but Ether ETH|MET is 1:500!). As someone who is almost entirely a spread (and butterfly) trader the higher cost of the micro's makes most of what I do unfeasible. I actually did do some 10Y|2YY spreads today, as much to say I've done them as anything. Very surprised to see that the implication in the 10Y|2YY Oct22 contract isn't enabled. I also did some ZT|ZN's as well moving some of my long ZN position to ZT.

Any chance you could elaborate on little more on this. Why would I prefer to be short DV01?

Schnook View Post
If I were looking to put on a 2s 10s steepener here I'd be looking at a bear steepener, that is, long end yields moving higher as opposed to (or more than) short end yields moving lower. This, being a bearish expression, implies you'd prefer to be net short DV01 rather than net long when all is said and done.


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 TWDsje   is a Vendor
 
 
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I've discovered with micro yield futures that there is a basis difference between the futures and the cash yields. Just like there is with everything else. The basis difference is usually at least 1bp, and that lines up with the 1bp spread you get in the less active micro instruments. I was able to see this by looking at live data from TradeWeb for a month. This helps explains why the robots hold the spreads that they do. It's just the best arbitrage they can do when there's not much activity.

So you can't just always use a market order or auto rollover stuff. You'll need to leg in and out yourself, and you'll need to have some idea of what the market makers are doing at that time. Say rates are increasing where the offer you get is fair, but the bid is stupid. So if I'm going to leg in or out of a spread trade I'll put my limit sell out first. If I can get the bad side filled on limit I avoid having to pay up a basis point on the trade. Once that fills then I can buy into the other leg with a market order to minimize the time I'm exposed to the risk of a single leg.

You can also just wait for the spread to come in. There are points where the spread will come in a bit when volatility contracts. It's also possible to sort of non verbally negotiate with the market makers by placing your own limit orders. So you have to work for it, but it's still possible to facilitate these sorts of trades. Even if you're trading a little bit of size. Although after 10 contracts I don't really see why you wouldn't switch to the regular size instruments. The same sort of ideas apply to when you roll. Liquidity gets pretty sketchy on the last day of the roll so you need to be strategic about your timing.

I've caught a decent flattener or two this year from that, but I still find it incredibly difficult to predict individual moves in spreads. It seems to me that the game there is really to just market make on the flattener side, and then hope you're not there when the big steepener comes. I still spend more effort on intraday speculation trades off news etc on 10YR, and the micro's are awesome for that.

- SpeculatorSeth
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 Schnook 
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@SMCJB I generally associate steepeners with sell-offs and flatteners with rallies, hence the bias to lean short in a steepener. I guess this is pretty consensus but I don't feel compelled to fight it. I just don't see a ton of upside for the 2yr part of the curve right now.

The Eurodollars are currently pricing in another 75bp hike next week (seems like a lock after this latest CPI print) and then another 100 or so after that - maybe two more hikes of 50bp each for a terminal rate of 4.25-4.50% sometime early next year. The lowest contract on the Eurodollar curve is EDH3, which closed at 95.41 (4.59%) vs. a 2yr note yield of 3.87% today. The entire eurodollar curve beyond EDH3 is inverted, with implied LIBOR dropping back down to a 3-handle in late 2023/ early 2024.

The only way the front end rallies meaningfully here is if the Fed hard pivots and adopts an aggressive easing posture inside of the next six months. I certainly wouldn't rule that out, but such a sudden pivot would likely only occur under dire economic circumstances, in which case the long end would probably continue to outperform in a flight-to-quality-driven bull flattener heading into that hard pivot.

Again, I can't rule that out. Things could get really ugly this winter. But in order for the steepener to perform I think you need to see inflationary pressures persist and the economy and labor market somehow stay afloat for the time being so that QT can run its due course. Watch how these huge treasury bond auctions go, month after month, without the Fed there to support them...

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 SMCJB 
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@Schnook thanks again for the post. I have a much better understanding of Eurodollars (GE) and Fed Funds (ZQ) (which are both 100-yield products) than I do the Treasuries (which are price products). (Off topic I assume you have seen CME has announced the final transition plans for Eurodollars to 90 day SOFR in April). While I understand yield and duration math I have far less experience in actually trading the price products rather than yield products. For now I'm going to continue to move my current 10yr (ZN) position to 2yr's (ZT).

Just in case anybody saw this and is interested, I ran some margin calculations. I found it interesting how different the 2YY-10Y spread margin requirement was vs the ZN-ZT spread when compared to the outrights. Obviously this is due the additional duration risk of the price contracts.


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