Over the weekend we warned that just as everyone was convinced that the yield curve can only flatten from here, and was positioned massively on the long side of the 30Y future, the opposite was about to happen, and in a tweet highlighting the record net spec long positioning in 30Y futures, we said “here comes the mega steepener.”
Here comes the mega steepener pic.twitter.com/OHqmX4HzMA
— zerohedge (@zerohedge) December 17, 2017
And, sure enough, starting on Monday morning, the yield curve has blown out, driven by a sharp, violent positioning unwind as a result of the record net specs parked on the long end of the 30Y TSY who aggressively fled on both Monday and Tuesday, sending the 30Y 13 bps higher, the biggest two-day increase since the election …
…which in turn has steepened the yield curve for both US TSYs and German Bunds…
… as we explained earlier today when we commented that the driver appears to be a Bloomberg report that the head of Germany’s Federal Finance Agency says the government will seek to take advantage of persistently low interest rates and sell a greater volume of 30-year Bunds next year, and as a result, the share of 30-year security issuance will rise in 2018 compared with the current year, while the share of 10-year Bund sales will decline.
The rapid selloff instantly spread across the Atlantic and has resulted in the most violent 2-day steepenings in the 2s30s curve – now 14 bps wider since Monday morning – in over a year. Additionally, the yield spread between five- and 30-year Treasuries widened on Monday by the most since September.
And while we hope that readers traded accordingly, we know that at least one bond trader made a killing by betting that the groupthink in Trasurys was wrong, as it usually is, and as Bloomberg explained, made a “very timely bet on a selloff in the Treasuries market – and is about $60 million in the black because of it.“
Here are some more details from Bloomberg which recaps what we said over the weekend:
The 30-year Treasury yield has soared 13 basis points to start the week, the steepest two-day increase in a year. The selloff has caused pain for some, including hedge funds and other large speculators, who ramped up net long positions in Treasury bond futures to a near-record in the week through Dec. 12, according to Commodity Futures Trading Commission data.
Not everyone lost money however: those who correctly expected a “mega steepener” made a killing, and as Bloomberg reports today, “at least one large position amassed last week looks prescient. Someone bought 50,000 put options on bond futures at an average price of 1’04 ticks, according to a trader familiar with the transaction, wagering that the price of long-dated Treasuries would fall as 30-year yields increased. That price jumped to 2’19 ticks Tuesday amid a sustained climb in long-end yields to 2.82 percent, leaving the bet showing a profit of about $60 million.“
Some more details on the trade in question:
Last week, around 50k position was established in USG8 153 puts at an avg price of 1’04 ticks; the option is now priced at 1’60 in screens, showing profit of 56 ticks equating to ~$43.8m
Motivation behind large trade could either be new position, which targets 30Y yields ~2.80% breakeven (vs ~2.72% when the option traded last week), or a hedge against a short gamma position.
While the profit is undisputed, it is unclear if the trade was a one-leg prop, or a hedge pair:
Now, it could be a timely outright bet. But by the looks of it, it’s more likely a hedge against short volatility that just so happened to come before a steep selloff in an otherwise quiet period for long-term Treasuries.
Bloomberg adds that in earlier trading Tuesday, selling of bond option put spreads suggested rolling down the strike price from last week’s long position. Those new lower strike prices will profit from an extended selloff.
Of course, the trade’s profitability now depends on what happens next, and on the market’s reaction to the tax overhaul bill which just passed a vote in the House, and also whether the decline has scared away the speculators who thought the Treasury curve would only flatten further.
“While we’re confident in the longer-term prospects for a flattening, the combination of the headlines around tax legislation, the outside day in curves and the building positions suggests some scope for a material correction before we head flatter,” BMO Capital Markets strategists wrote in a note.
What they really mean is that until the “weak hands” get kicked off the 30Y end, the selling – and steepening – is set to continue, and that $60 million Profit is set to grow even bigger.