Tuesday 23 July 2013

Euro Bund ... Heresy to the monetarist Taliban

Tuesday 23rd July 2013

I’ve closed my US long bond short (When QE stops the long bond drops). It probably goes lower, but I reckon Bunds fall more precipitously from these levels. So yesterday I called up Jackie at ETX and shorted the German long bond, i.e. the Euro Bund Future at €144.20. The €144.20 implies that 10 year Bunds yield 1.26% pa. It would appear the lowest it has ever yielded since 1990 is 1.07%. That was in April last and corresponded to a price of €147.20. Therefore, €147.20 is probably about as high as it can go.
My reasons for shorting are as follows:

  • I reckon it inconceivable that the monetarist Taliban, otherwise known as the Bundesbank (BUBA), will permit long-term interest rates to reside at c. 1% for 10 years. However, it should be noted that they have allowed rates to be between 1-1.5% since mid-2012. How much longer before the BUBA says enough is enough I do not know, but I doubt it is 10, 8, 5, or even maybe just one more year.

  • The spread between German and US ten year notes is the widest it has been for 30 years. US Treasuries yield 2.85% while German Bunds yield 1.26%. Not that I wish to own either, but if I were a buyer I would much prefer 2.85% to 1.26%. Particularly as there is a risk that Germany may at some stage have to assume peripheral debt.

  • I suppose that the euro could appreciate against the dollar to mitigate the spread in yields, but as US interest rates are rising (and euro rates currently not) the dollar is likely only to get stronger. That makes holding US assets more attractive than low yielding euro's. On the other hand, were euro to strengthen, then one would imagine that precedes rising euro rates, which will kill off sub 2% yields. 

  • The ECB could print money and embark on its own QE, but that would be anathema to BUBA philosophy and likely lead to the breakup of the euro. I would imagine that short-term, Bunds may rally although then plummet as the BUBA gets back to business as usual, post its recent disastrous venture into monetary union. 

  • Finally, in technical terms, it appears weak. The price fell below the 200d ma in late May and has recovered over July. But a further, more severe leg down looks to be on the cards. 

In summary:
I reckon I'm looking at up to €3 loss on selling the Bund as compared to €8 or more gain should long-term rates head back to c. 2% or possibly higher. However, should I find myself down the €3, I would probably be inclined to double up. Do I think the monetarist Taliban will permit long-term rates to indefinitely be this low? Nein! 

RX1 Comdty - Generic Euro Bund
Source: Bloomberg
Yield on Generic Euro Bund
Source: Bloomberg
Yield spread against US Treasuries
Source: Bloomberg
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