Playing the Yield Gap

Trading Opportunity on Recent Weak Auction

According to Bloomberg, spreads between the 2 and 30 year notes hit their widest level since 1980. While we believe both long and short term rates will ultimately be higher at some point in our lifetime, the recent harsh over reaction to a weak 30 year bond auction could present investors with an opportunity for a short term trade. The 30 year yield has hit 4.4% numerous times through 2009 only to bounce back repeatedly. The current move brings the yield to its highest level in about 4 months of 4.5%. This may bring buyers back to the market on the benchmarks oversold condition.

Contra-Indicators and Bill “The Thrill” Gross

We have heard that rates are “simply too low” for some time and while this may currently may be the prevailing consensus, two potential indicators stick out that may prove otherwise; TLT – iShares Lehman 20+ Year Treasury Bond Fund large short interest, and the retail buyer interest of TBT – UltraShort Lehman 20+ Year Treasury.  This gives us the feeling that now is not necessarily the time for the 30 year yield to break out higher. In addition, Bond King Bill Gross continues to build positions in Treasuries, currently 48% in his flagship fund, with stimulus faucets tightening, he may just be right to keep doing so.

Investor can play the yield spread by buying TLT and shorting SHY -iShares Lehman 1-3 Year Treasury Bond Fund.

The graph below illustrates the steepness of the yield curve relative to historical levels.

(Click Graph to Enlarge)

Source: ETFDesk

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