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Earl Adamy asked, amongst other things:
>
> So here we are looking at the very flat yield curve anchored at the long end
> by the bond which has already discounted a rate cut and figure that the
> shorter maturities would drop as they shortened in duration toward Fed
> Funds? Hasn't a flat yield curve, such as we have now, already discounted
> most of the rate cut at the short end and thus wouldn't current spread
> prices have already discounted the profits to be made i.e. is this the kind
> of trade which must be put on as flattening begins rather than the day
> before a Fed meeting? Would it be unusual for the long bond to rise a bit in
> yield even as the ten falls in yield?
Well, remember these are only opinions, but here goes. When the Fed makes a
policy change, it seldom is isolated and almost never does the policy shift end
in just a single rate change, but rather, it's mor likely to play out as a
string of changes over time. Like most anticipated events in the markets, much
of the price action depends upon the expectations of the market going into the
event. And so going into today's Fed meeting, we have a bond yield that surely
anticipates a rate cut. Are the market participants expecting a 1/4 point cut?
1/2 point cut? More? There will be all sorts of opinions and reasons given for
different expectations, but only the price action after action [or inaction] by
the Fed will tell the tale.
If the rate cut is fairly well anticipated, it would indeed not be unusual for
the bond to lose some ground after the event, at least initially. But if the
market begins to think, after taking profits, that the Fed is likely to again
change rates, the whole dance begins again. As I said, the Fed rarely changes
policy and then makes only one cut or increase. On the pullback of these
spreads, it's wise to get tuned into their charts and watch them just like you
watch a chart of any commodity or stock.
Robert is absolutley correct when he posted today about people being blown out
of spreads, some of them yield curve spreads. I just recently did a piece of
consulting for a top ten money center bank that was feeling the heat on mortgage
backed securites spread against two and ten year US notes. The same rules apply
to trading interest rate spreads as apply to trading anything: Have your exit
stops ready when you put on the trade, because you can be wrong about any trade.
I chart my spreads on end of day data, and my charting software allows me to
create spreads of any commodity or index or future against each other. The
charts are simple line charts, not O-H-L-C, but that's ok. I am looking at them
to determine support and resistance and the absolute levels.
I think that will answer a portion of you questions. I'll answer the questions
about currencies and devaluations/funding in a seperate post this afternoon,
after we do or do not cut rates. I hope other people that are well-versed in
trading interest rate instruments and spreads will jump in and add their opinion
or correct any errors. For those of us that don't have code to share, helping to
generate trade ideas or sharing experience is our equivalent. And it's a gift
that keeps on giving.
Best,
Tim Morge
> Again to the mechanics: the spread is quoted and traded as a single symbol?
> Are there any concerns regarding liquidity of certain spreads? Would one
> look at a chart of the spread and analyze it technically in similar manner
> to a single contract? If so, where does one obtain history of the actual
> spread pricing as opposed to creating synthetic spread prices by netting the
> contracts? An example?
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