SHORT US 10 YEAR GOVTERMENT BONDS
TOP TRADE
Federal Reserve On The Move
believes that the US Federal Reserve will begin raising interest rates in 2016. Although we believe it is
unlikely that they will raise interest rates at the October Federal Reserve meeting, we do believe that raising rates at the December meeting is very likely. The US economy appears to be well on the recovery path.
Unemployment numbers continue to be very positive for the economic health of the economy and are now firms with the Federal Reserves desired levels. In addition to this, the Federal Reserve Chairman, Janet
Yellen has previously highlighted to the market that Federal Reserve anticipate increasing interest rates this year. We believe this as a clear message to the market to prepare for higher interest rates. Accordingly, are entering a short US 10 year government treasury bond trade. The value of this trade will increase in value as US bond yields go higher.
believes the US Federal Reserve will increase interest
SHORT US 10 YEAR
rates in 2016
GOVTERMENT BONDS
TRADE DETAILS
US unemployment is very low
Opening Price
2.028%
The federal Reserve has told the market they anticipate to
Current Price
2.232%
increase interest rates this year
Date opened
27 Oct 15
We are selling a US 10 year bond at 2.028%
Profit/Loss Realised
New Trade
The value of the trade will increase as US yields go higher
Selling US 10 Year Government Bond
Tomorrow morning the US Federal Reserve makes its rate policy decision. Although does
not believe the Federal Reserve will increase interest rates at the October meeting, we do
believe that at the December meeting there is a very good chance interest rates will go up.
If they do raise interest rates at the December meeting, we anticipate US bond yields to go
materially higher than at the current juncture. Currently, the US 10 government bond yield sits
at 2.028% and has keep within a tight 0.8% range of 1.67% to 2.48% for 2015. At 2.028% the
bond yield is at the lower end of the range and we believe that it can go materially higher when
the Federal Reserve begins to raise interest rates.
27 November 2015
As illustrated by the graph below, interest rates in 2000 where as high as 7%. Although do
not believe these levels will be reached again over the medium term, we do believe that at
2.028% there is significant room for interest rates to go higher.
Investment Thesis – Why we like it
The US federal Reserve Chairman Janet Yellen along with multiple other influential
Federal Reserve voting members have been very vocal in telling the public that they
anticipate that they will begin increase interest rates in 2015. Yellen’s Speech extracts
are below.
“It will likely be appropriate to raise the target range of the federal-funds rate sometime
later this year and to continue boosting short-term rates at a gradual pace thereafter
as the labor market improves further and inflation moves back to our 2% objective,”
“Continuing to hold short-term interest rates near zero well after real activity has
returned to normal and headwinds have faded could encourage excessive leverage and
other forms of inappropriate risk-taking that might undermine financial stability,”
“The more prudent strategy is to begin tightening in a timely fashion and at a gradual
pace, adjusting policy as needed in light of incoming data.”
The US unemployment rate continues to improve month to month currently sitting at
5.1% comfortably within the Federal Reserve’s target band of between 4.7% to 5.8%.
We believe entering a short position at 2.028% offers excellent risk reward. This level
is towards the bottom end of its historical range and therefore it has a lot of potential
to increase. believes that once the Federal Reserve begins increasing interest
rates they will continue to increase them gradually over time. We believe this will result
in the US 10 year bond yield continually increasing in yield.
27 November 2015
As illustrate in the chart above, we are able to observe the US 10 year bond yield
against the US equity market (S&P 500) dividend yield. This is a measure typically used
by investors to assess the relative value of holding a bond vs holding equities from an
income perspective. As we can see above, the bond yield (2.028%) is below that of the
equity dividend yield (2.19%). This means that investors receive more income from
bonds over equities at present. Accordingly, it does not appear like owing bonds is a
great value decisions.
Risks
A risk to this trade is that the US federal Reserve decides not to raise interest rates
because the economy’s inflation is too low. The current inflation rate is around 1.5%
and is below where the Federal Reserve what the rate to be. Federal Reserve Chairman
Janet Yellen says:
“Inflation is, as you mentioned, running considerably below our 2% objective.
Nevertheless, the committee judges that an important reason for that is the declines in
energy prices and the prices of non-energy imports,”
“But I expect that inflation will return to 2% over the next few years as the temporary
factors weighing on inflation wane.”
Clearly, the inflation rate remains a concern for the Federal Reserve, but they
anticipate the rate to raise above the target of 2% in the medium term future.
At the September Federal Reserve meeting, the recent global slowdown was
highlighted as the reason for delaying the start of their interest rate increasing cycle.
This mainly revolves around the slowdown in the Chinese economy. However,
believes that China is in for slow landing and therefore although it remains at the
forefront our minds, we don’t not anticipate this preventing the Federal Reserve from
increasing rates this year.
Geo-political risks are always a concern to any investment. If there was a period of
turbulence we would expect bond yields to decline as investor’s seek safety from other
riskier assets. As these events are impossible to predict, we don’t believe it is a major
risk factor in our investment thesis.
27 November 2015
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27 November 2015