Who are the idiots buying bonds for 1% interest?

[Martinghoul]

Quote from tradingjournals:
Big D, Martinghoul and others: Is it possible that the yield of the 2's get negative? I am asking because I just found out that I got filled on an order I did not cancel on the 2's that was at 109'225, and I want to double check whether the assumption of positive yield is something I should count on? If yes, I can take the risk of a 1% rise that would result from a zero yield.

Well, these are nominal yields, so it's unlikely that they go properly negative. However, it has happened before and, in theory, can happen again. 3m bills, for instance, did trade negative during the height of the '08 crisis. In Japan and Switzerland negative money-mkt rates have also been observed at times in the past.

One thing to think about is that the price of the futures may rise more or less than 1% implied by the move in the yield of the 2y bond. Especially, in an environment where 2y yields approach 0% and there's all sorts of balance sheet constraints, which can cause the basis to trade all over the place.

 

[tradingjournals]

Quote from The Big D:

That's an accurate statement. I believe, especially related to the Sep 2s, that there are a lot of people who have to sell, and no one who really needs to buy. This is evidenced by the fact that the 5s made new highs on Monday (there are still non-speculative buyers for 5s and 10s IMO) but the 2s did not. In other words, the speculative longs are the weak hand in the market.

This is very powerful insight. Thanks for sharing. I like the idea that we know that the longs have to close by expiration (particularly the speculative longs). We also know they would sell because they have a profit, and would not risk let it go.

I like the combination of the deadline, and the incentive to sell. In essence we are positioning our self before the crowd decide to take the exit.

Big D and Martinghoul: Thanks to both of you for answering my question related to zero yield. Excellent and very helpful information. Cheers folks!

 

[Martinghoul]

Quote from The Big D:
That's an accurate statement. I believe, especially related to the Sep 2s, that there are a lot of people who have to sell, and no one who really needs to buy. This is evidenced by the fact that the 5s made new highs on Monday (there are still non-speculative buyers for 5s and 10s IMO) but the 2s did not. In other words, the speculative longs are the weak hand in the market.

If the economy somehow improves, that's just another way I can win.

True, if the economy improves you win. Can I ask you, for purposes of illustrating something, how many contracts, roughly, you sold?

Quote from The Big D:
Presumably a negative yield on T-bonds would equate to someone with a gun forcing you to buy them. IMO implausible.

Implausible, yes... Possible, most definitely. It's not about forcing YOU to buy them, but about someone somewhere with a lot of money needing a safe place to park their cash (just like it happened in 08).

 

[Martinghoul]

Quote from tradingjournals:
This is very powerful insight. Thanks for sharing. I like the idea that we know that the longs have to close by expiration (particularly the speculative longs). We also know they would sell because they have a profit, and would not risk let it go.

I like the combination of the deadline, and the incentive to sell. In essence we are positioning our self before the crowd decide to take the exit.

Erm, this is very naive, tj. The longs don't have to close anything by expiration. Either I can take delivery of the bonds (which I would happily do, if it makes me money) or I can roll my position into the next contract. Neither of the two would necessarily have a negative impact on my PNL.

Don't you think that the mkt would have figured out by now how to front-run the forced selling of the current contract, if it were something that people actually HAD to do? If it were this easy, I wouldn't have a job. Trading the roll is an art in itself and it's certainly not as trivial as selling a few days before the first notice date.

 

[The Big D]

Quote from Martinghoul:
True, if the economy improves you win. Can I ask you, for purposes of illustrating something, how many contracts, roughly, you sold?

< 20

Implausible, yes... Possible, most definitely. It's not about forcing YOU to buy them, but about someone somewhere with a lot of money needing a safe place to park their cash (just like it happened in 08).

I can at the limits of reason imagine that in the cash market if you trust the Treasury more than any bank in the world, but the futures market? If you don't trust any bank, you can't trust CME either.

 

[tradingjournals]

Quote from Martinghoul:

Either I can take delivery of the bonds (which I would happily do, if it makes me money) ..

For fun and for some truth: do you really think longs have the funds to take delivery ? Is it not all just a leveraged position

You have deep pockets Martinghoul if you can take delivery.

 

[The Big D]

Quote from Martinghoul:

Erm, this is very naive, tj. The longs don't have to close anything by expiration. Either I can take delivery of the bonds (which I would happily do, if it makes me money) or I can roll my position into the next contract. Neither of the two would necessarily have a negative impact on my PNL.

Don't you think that the mkt would have figured out by now how to front-run the forced selling of the current contract, if it were something that people actually HAD to do? If it were this easy, I wouldn't have a job. Trading the roll is an art in itself and it's certainly not as trivial as selling a few days before the first notice date.

This is confusing the issue. In a situation where there are both speculative longs AND speculative shorts in roughly equal numbers, the roll is uninteresting. That's not what we have here - we have (in general terms) speculative longs and funds intending to make delivery.

Now, it's possible that some of the longs will be forced to take delivery, but you and I both know speculators hate to do that because what they're delivered may be somewhat illiquid. That's the whole point of the futures contract in the first place and the whole reason they didn't just buy bonds in the cash market up front.

As TJ mentioned, their cash/margin situation also has to be considered.

 

[Martinghoul]

Quote from tradingjournals:
For fun and for some truth: do you really think longs have the funds to take delivery ? Is it not all just a leveraged position

You have deep pockets Martinghoul if you can take delivery.

Yes, but do you truly think that the speculators that aren't able to take/make delivery are a significant enough proportion of the mkt to dictate its behavior?

Point is that if the roll gets to the point where I, as a speculator capable of both taking and making delivery, see that it's sufficiently distorted by the less capable speculators, I will bring it back in line and make money on it. That's what fixed income relative value trading is all about.

Quote from The Big D:
I can at the limits of reason imagine that in the cash market if you trust the Treasury more than any bank in the world, but the futures market? If you don't trust any bank, you can't trust CME either.

Actually, you'd be shocked at the sort of stuff that went on during 08 in the basis mkt. And, actually, I can very easily see myself happily lending money to a central clearer rather than to a single specific counterparty. After all, that's what the OTC -> exchange push is all about.

Quote from The Big D:
This is confusing the issue. In a situation where there are both speculative longs AND speculative shorts in roughly equal numbers, the roll is uninteresting. That's not what we have here - we have (in general terms) speculative longs and funds intending to make delivery.

Could be... I have not seen any indication of this. If this is the case, I'd better get cracking on those rolls .

 

[The Big D]

Quote from Martinghoul:

Yes, but do you truly think that the speculators that aren't able to take/make delivery are a significant enough proportion of the mkt to dictate its behavior?

Given that we had people all but trying to sell bonds in this thread a week ago, I'm thinking definitely so. Part of this trade's justification was the general sentiment that the situation had gotten out of hand - I wouldn't have been surprised to see guys on street corners with sandwitch boards with "Buy Bonds" printed on them.

And yes, it's possible for bigger speculators to take delivery, but they then have to either sell in cash or wait for Dec. Both "solutions" have issues.

 

[The Big D]

Quote from Martinghoul:
Actually, you'd be shocked at the sort of stuff that went on during 08 in the basis mkt. And, actually, I can very easily see myself happily lending money to a central clearer rather than to a single specific counterparty. After all, that's what the OTC -> exchange push is all about./B]

It's an interesting argument. I can't think of a single negative yield event that wasn't an excellent short opportunity though.

Interestingly, the spread appears to have widened to a more reasonable value.