Treasury Futures Positioned For Epic Mean Reversion
As the Federal Reserve prepares to raise the Federal Funds Rate for the 1st time in 2016 markets have spent the last several weeks getting ahead of Wednesday’s decision and the key will lie in the language of the statement and details conveyed during Fed Chair Yellen’s press conference which will begin at 2:30pm EST Wednesday. Despite the fact that the Fed will raise the Fed Funds Rate on Wednesday the risks to long-term rates lie firmly to the downside, at least over the near-term.
Looking at positioning in Treasury Bond futures commercial traders (banks and swap dealers) have never had such a large net long position in 10-year Treasury Note futures:
Not only are commercial traders currently positioned with a ~$55 billion net notional long position in 10-year note futures, but this has also been an extraordinary move in interest rates both in terms of trajectory and magnitude. It’s officially a 5-standard deviation move in rates and positioning is as one-sided as it’s ever been:
Futures speculators as a whole have gone from slightly net long during the summer to overtly and grossly net short as the year draws to a close. From a positioning, sentiment, and market structure perspective the Treasury complex could not be more ripe for a short covering rally during the final weeks of 2016.
To add some more weight to this idea of year end mean reversions there is likely to be some quarter/year end rebalancing which means portfolio managers’ will sell equities and buy Treasuries in order to rebalance portfolios to the desired weighting.
Given the strong positive correlation between Treasury bond prices and gold recently, going long gold is another way for traders to play an imminent mean reversion in the Treasury complex:
Positioning is more one-sided than it has ever been and sentiment is arguably even more extreme. Finally, from a technical perspective there are early signs that a topping process is underway with momentum fading quickly after the post-election surge in yields and the initial makings of a double-top near the 2.50% yield level in the 10-year note:
If you look to the left of the above chart you can see the last time the Fed raised the Fed Funds Rate circled in red - this turned out to be an important top in yields after which the 10-year yield fell nearly 80 basis points over the next couple of months. A similar setup is occurring heading into this meeting in terms of a multi-week consolidation following a rally in yields.
The key technical levels on the 10-year note yield are resistance at 2.50% with initial support near 2.35% with a much more significant support zone near 2.15%-2.20%; a breakdown below 2.35% will leave what looks to be a significant double-top near 2.50% in its wake.
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