Yesterday in my MorningWord (Skyfall for Treasury Yields?) I offered my take on the prior night Fast Money guest Raoul Pal‘s view U.S Treasury yields were likely to go lower over the course of the next year, despite the Fed’s recent rate increase last month. This is obviously a non-consensus view, and it appears to not only be grounded in the possibility that the U.S. will enter a recession during this period, but also that U.S. Treasuries have proven to be one of the few safe haven risk assets in times of economic and financial market stress:
Taking a look of the 20 year Treasury bond etf, (TLT) it’s apparent that there is no greater safe haven trade than U.S. Treasuries. Look at the spike in late 2008 during our financial crisis, the spike in 2011 that led to higher highs in 2012 during Europe’s sovereign debt crisis and then again early last year when it became apparent that the global economic recovery from the depths of both crisis was fragile at best. That eventually succumbed by year end to the Fed’s official end of ZIRP in December:
What’s clear is that the TLT has been in a 10 year uptrend, making a series of higher highs and higher lows. And if Raoul Pal is correct (that the U.S. will head into a recession and the U.S. Fed will have to do a U-Turn on tightening and actually start easing again) then the trend is your friend.
Today I want to take one more crack at the TLT (iShares 20 year Treasury bond etf) chart over the last five years. What’s interesting to me is that the pattern over the last two years looks very similar to that of 2011 and 2012, prior to the nearly 20% decline in 2013 from its May high, which has been labeled the “taper tantrum” once the Fed indicated that they would Taper their Quantitative Easing:
So what’s different this time? Why will the TLT not fail as it did in mid 2013 and crash through the uptrend and $120 support? Simple, it sure seems like Treasury bond yields are NOT going up. They barely budged when the Fed raised the fed funds rate last month for the first time in 9 years, and given the current state of the global economy, and the downward pressure on global risk assets, and the relative strength of the U.S. dollar, it appears that the Fed will likely have to take a more accommodative monetary stance than they had expected before they attempted to normalize rates.
I am hard-pressed to think of too many events that would cause the Fed in the first half of 2016 to panic and continue to raise rates. The probability of a rate increase at the Fed’s April meeting has dropped this month from north of 50% to about 30% in the last two weeks, from Bloomberg:
Importantly, this is also up from the low teens percent back in October, the last time global growth fears were gripping global markets.
So what’s the trade?
If you are finding it increasingly hard to find places to put money to work besides putting on hedges, then you might want to consider long biased view in U.S. Treasuries that seem to have little gap risk to the downside, and the increasingly likely possibility for upside if market volatility across asset classes and geographies continues.
*Trade: TLT ($125) Buy April 120 / 130 Risk Reversal for even money
-Sell to open 1 April 120 put at 1.70
-Buy to open 1 April 130 call for 1.70
Break-Even on April Expiration:
Profits: above 130, up 4%
Losses: below 120, down 4%
Mark to Market: prior to expiration the position will have losses as the etf moves closer to, or below the short put strike, or gains as the etf moves closer to, or above the long call strike.
Neutral: if the etf is between 120 and 130 on April expiration there will be no gain or loss as the position was put on for even money.
Rationale: This trade is most likely is a wash, having a small gain or loss on expiration, but this trade also has the potential to offer an asymmetric payout to the upside in the event of a full blown market panic. On the downside, the put sale down at support makes sense, as I think the likelihood of a crash lower vs spike higher is skewed to the latter. Also short puts in an instrument like the TLT lacks the idiosyncratic risk of being short a put in a controversial stock like Apple or Disney that have single stock event gap risk.