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It's a snoozy Friday and bonds have been moving basically sideways for a couple of weeks here, so I haven't had much to say. That range on 10yr yields is <6bps wide.
(Incidentally, I think "sideways" is path of least resistance for while).
Mini-thread. 1/x
(Incidentally, I think "sideways" is path of least resistance for while).
Mini-thread. 1/x
My "sideways" call stems from my opinion that forces of fiscal adventurism and monpol dovishness are roughly balanced here. That was evidenced last Friday in markets unresponsive to mix of @JoeBiden fiscal proposal against JayPow's microwave-side chat. 2/x
I'm not sure what catalyst breaks this balance, but it's probably a few months off, and my bet is the next move will be for somewhat higher rates. So what do we bond PM-types do when rates move sideways for a while? 3/x
We look for non-directional source of return, which fall into three broad categories:
1) Carry
2) Short vol
3) Roll-down
I'll go through each quickly. 4/x
1) Carry
2) Short vol
3) Roll-down
I'll go through each quickly. 4/x
1) Carry is just the income generated by the yield of an instrument, often adjusted by financing cost. For example, the 30yr UST has a yield of 1.86%, financing is 5bps, so your carry is 181bps. Higher risk bonds generally have higher carry. 5/x
2) Short vol is selling options to collect premium. You can do this explicitly in listed ED/UST options or in OTC swaptions depending on your mandate. Or you can buy option-embedded bonds like MBS. Not a lot of juice in short rate vol right now, but it's something. 6/x
3) Roll-down is the income generated by the passage of time over and above carry. It's created when a bond goes from being discounted at a "x" yr interest rate to an "x-t" yr interest rate, where t is the passage of time. 7/x
3) Cont'd this is actually the most interesting to me at the moment. Roll-down is best when and where the yield curve is steep. The curve is steepest between the 5-7yr points with a yield differential of 33bps (17bps/yr) and 7yr USTs carry 71bps/yr. 8/x
In a unch rates, 7yr UST total returns will run ~88bps/yr. DV01, a measure of risk, on a 7yr UST is $670/mm; divide the two and the expected return/risk ratio on 7s is 0.13x.
Compare to 10s at 0.12x and 5s at 0.10x, and 7s are best prospect in flat rate scenario. 9/x
Compare to 10s at 0.12x and 5s at 0.10x, and 7s are best prospect in flat rate scenario. 9/x
So that's how at least one PM is thinking about allocating rates capital for the short term. Fin.
