Last Weeks GovtTrader Supply Imbalance NewsLetter

My apologies for not starting my EOD market commentary.  I had the flu for a full 2 weeks in January, and it knocked me out.  I got back into the market last week just in time for the Friday supply imbalance.  Here is the newsletter sent to subscribers on Thursday afternoon.

As you can see from this chart...the supply imbalance could not have played out any more perfect.  My position was never "tested" by the market (newsletter was sent out where you see the cross-hairs on the chart below).

My P&L on this trade was +28 ZN ticks (fully levered) in just about 24 hours.
That comes to just over +30% return on AUM in just one day.

---------- Forwarded message ----------
From: Govt Trader <govttrader@gmail.com>
Date: Thu, Jan 29, 2015 at 4:09 PM
Subject: GovtTrader Supply Imbalance NewsLetter
To:

Today the UST model has triggered a supply imbalance in ZN futures.

Yesterday was a P-up, and today was a non-facilitating sell imbalance (meaning *they* tried to sell the mkt early, but the mkt came right back up in the afternoon).

This tells us that the UST mkt (specifically ZNH5) has an embedded skew to higher prices.

ZN is currently trading 130-04 while ES is @ 2014

The ZN mode today is 130-05 at the lowest.  This makes 129-22 the bottom of today's bell curve...and that *should* be the lowest ZN can trade with this embedded skew.  The most likely path for ZN should take it to above the local high @ 130-20...possibly to as high as 131-08.  Nothing is guaranteed in trading of course.

Tomorrow in the month-end trade...which should be supportive of this UST rally.

As you all saw on twitter, i bought both the 7yr auction (ZN @ 130-02), and then ZN after the auction @ 129-30 (so my avg price is long ZN @ 130-00).

My stop is the ZN local low @ 129-16...but unless ES rallies to 2062 (the top of its January bell curve) we *should* not get anywhere close to my stop level.

Remember, everything in trading is based on probabilities.  We never have 100% certainty.  Even tho i'm confident that this will play out in my favor...that is not a guarantee.

Since these embedded supply imbalances / skew are the highest probability trades, my position is larger than usual.  While there is no guarantee that we will see a short squeeze rally in ZN tomorrow (or possibly early next week), the odds are greater than 70%, and that is what i am playing for.

My target for this ZN long is 130-27 --> 131-08.  That is a large range...but short squeezes are notoriously difficult to predict, both in time and price.

If you have any questions, please feel free to reply by email.

GovtTrader.

New Years Resolution

I haven't been blogging much for the past year as i've migrated my intraday commentary over to twitter.  However, i think an end-of-day commentary would be helpful, both to myself, and probably to some of my readers too, so that's my New Years Resolution.  I used to put out an EOD commentary when i was a primary dealer, so its back to the good old days.

Trade Well,
-govttrader

As Pomised...The Most Recent GovtTrader Newsletter...

---------- Forwarded message ----------
From: Govt Trader
Date: Fri, Nov 14, 2014
Subject: GovtTrader NewsLetter

Today the treasury market completed a 2nd consecutive day of bullish pattern price action.  Volumes may be on the low side (only 350bln 10yr equivs as i write this at 3pm), but the price action is clearly bullish.

Yesterday, going into and then coming out of the 30yr bond auction was a P-up.  The mkt repriced lower because of the tail in the 30yr bond auction, and then was clearly bought to create the P.

Today, the mkt sold off early with the 8:30 data, and then was bought again.  Today's profile also looks like a P-up.

2 consecutive days of P-up formations like this are indicative of an under-supply imbalance, and skew the market to higher prices.

If you are a fan of Mark Fisher's ACD system, yesterday was an A-up, and today was a failed A-Down followed by a C-up...which gives +7 on the number line.  The market has turned bullish, and dips should be bought.

You can watch a video of the Mark Fisher Trading Seminar on the GovtTrader.com blog

The weekly ZN mode / VWAP is 126-12.  Ideally, we will be able to buy that level next week...though the probability is on the low side.  I may be a little more aggressive (126-16 maybe?).  Regardless, next week should be very active in the markets, and the model has turned bullish.   I will be buying dips.

Newsletter sent out this afternoon...

Sent out a newsletter to subscribers this afternoon.  Will post the newsletter here on the blog when the trade is over.

Last Night's GovtTrader Newsletter

This is the GovtTrader newsletter sent out to subscribers after the close on Tuesday, April 8.
Annotations made after the fact are in italics

Since NFP we've seen some wild moves in the capital markets. 

In the treasury market, we've seen 3 consecutive days of bullish price formations.  First we had a "P-up" formation on NFP Friday, and then we've had 2 days of buy imbalances.  A buy-imbalance is simply a day where the profile looks like a bell curve, but we know that the majority of activity was buying.  If the market price eventually falls back down below the mode, then we call that day a "non-facilitating" buy imbalance ("they" tried to buy the mkt to get the price high, but price falls back down) (that would be bearish).  If however price stays in the upper 50%, then we just call that day a buy imbalance .  If price moves vertically away from the mode and stays in the upper 1/3rd of the range, then we call that a P-up day (and also a buy imbalance).  It could be argued that today was a P-up (tho the shape of the px action was more diagonal than vertical....suffice it to say, today is a buy imbalance formation).  With 3 bullish formations in a row, treasuries trading near the "cheap" end of the range vs USD/JPY, and the 10yr auction tomorrow, the stage has been set for a short covering rally.

1)  We know from the JPM survey that there is a large community of shorts, plus a new community of freshly initiated longs. 
2)  We know from the trading volume yesterday and today that the majority of those shorts have not covered. 
3)  We know that going into the 10yr auction short and bidding to cover is a common strategy. 

So, the mkt will most likely be going into the 10yr auction tomorrow with a large short base.  If the 10yr auction comes strong and many of those shorts don't get to cover their shorts in the auction (what we call "stopping short") (which is what i expect), the post auction px action should be a high volume, high velocity, high volatility short covering rally.

There are a couple ways to play for this type of short covering rally (you can just go into the auction long 10yr futures, or you can buy in the mkt after the auction after the 1st repricing and give up the auction surprise), however there is another way.  Implied vol in the ZN options mkt is on the low end of the historical range @ 4%  The 124.5 1-week ZN Call option (1/2 a point OTM) was 2 bid, offered at 4 today.  This option expires Friday so only has 3 days remaining to expiry, which is why it is so cheap.   

These options were offered @ 2/64ths on the morning of April 9, and traded as high as 5/64ths during the short covering rally today.  ZN traded up to 124-08+ during the short covering rally which took place after the FOMC minutes.  I bought these options @ 2/64ths, and sold them at 3 & 4/64ths

I expect ZN to ease off the highs of the day, and return towards the 123-25 mode at some point between tonight and tomorrow (the low was indeed 123-23).  This should reduce the px of this option by 1/64th.  So, if i can buy this Call option @ 1-2/64ths, i plan on spending 1-2% of my AUM to buy it.  If we get the short covering rally that i am playing for, then ZN can trade above 124-16, and this option should trade above 10-12/64ths.  (i was the first bidder for this option @ 1/64th all day, but they never traded...the high ZN price in the following overnight session was 124-17)

This is the most focused and low risk vs potential reward strategy that i see in the mkt from the current environment.  There is always the risk that we don't get the short covering rally and this option expires worthless. However, that's not what i *think* will happen.

Since this option is trading so cheap, we get a lot of leverage for a limited amount of capped risk.  I am quite honestly surprised these options are trading so cheap...but that's why they call it a market.

Statistically, the NFP move is a fade, and i suspect that is why vol is so cheap this week.  However, i think the mkt has set itself up for an outsized move, and i want to position myself to take advantage of the potential situation.

If implied vol was expensive, then i would sell ATM Puts, but vol is cheap, so selling options doesn't seem like the best strategy to me right now.

30yr UST Auction Post-Mortem

Today the treasury sold 13bln 30yr bonds (re-opened the Nov-2043 issue).

After yesterdays fireworks following the weak 10yr auction, tensions were high going into today's 30yr bond auction.  Going into the auction, the 30yr bond had been outperforming on the curve all day (which is surprising on a 30yr bond auction day).  The belly/front-end of the curve saw decent selling, but the 30yr did not (again, very surprising for a bond auction day).

Going into the auction, the wi 30yr ("wi" = "when issued" - which is what we call a bond before it is auctioned) was trading 3.89%.  The 5yr and 7yr points on the curve were trading near the lows of the day (the 30yr bond was trading 97-17+ @ 3.89%....and the low price pre-auction had been 97-12...so we went in to the auction pretty close to the low).  The auction priced 97-10+ @ 3.90% (so, a 1 basis point tail = 1bp cheaper than where the bonds were trading in the secondary market going into the auction). 

Now, this is the exact same type of result that we saw at yesterdays 10yr auction (1bp tail) but the lead up to the auction was entirely different, and the price action post-auction is also completely different.  Yesterday, the market rallied right into the auction and went in right near the day's high. Today, the mkt sold off pre-auction, and we went in close to the lows (the 30yr bond was strong on the curve...but outright price was still lower on the day - especially if you look at the belly of the curve).  Yesterday, the auction tailed 1bp, and the mkt sold off like a banshee.  Today, the auction tailed 1bp, and the mkt hasn't really gone anywhere...the mkt is going sideways in-between the auction stop price and the pre-auction price.  This is VERY RARE for a 30yr auction.  The result is almost always a big surprise one way or the other.  I was saying before the auction that the entire mkt felt very weak, which indicated a tail was coming.  Since i went into the auction short and was bidding to cover that short and get flat, i was hoping for a much larger than 1bp tail.  The result of only a 1bp tail was a "meh" result (still made a trading profit, but i was hoping for more).  For a 30yr bond auction, i would consider a 1bp tail a practically "screws" result...and that explains why the mkt is just chopping sideways since the auction..this means the mkt was perfectly positioned, everybody is happy and nobody exited the auction with too many or too few bonds from the result.

If you are wondering "what next?"  Well, next week the US treasury is auctioning 2yr, 5yr and 7yr notes.  This is unusual (these auctions typically take place in the last week of the month) but the holiday calendar has pushed things up.  This may partially explain the weakness in the 2-7yr part of the yield curve.  Also of concern to the belly and front-end of the curve is the article recently published in the NY times talking about Fisher's views of forward guidance.  His comments on forward guidance were very "indecisive" regarding the front end of the curve, where the mkt has experienced and was expecting the more reliable "lower for longer" mantra.  This combined with the auctions next week are both reasons for the front end of the curve to sell-off...and so it has.

Until we get new information, or surprising price action, i'll be flat and waiting.

If you would like to see my thoughts on the UST market intraday as well as see my actual trades in real-time, then i would suggest joining my private twitter feed.  The signup link is on the top-right of my blog.

10yr Auction Post Mortem + 30yr Auction Thoughts

Today the US Treasury auctioned 21bln 10yr notes (re-opened the Nov-2023 issue). 

Going into today's 10yr auction, ever since the NFP number at 8:30am on last Friday, the US treasury market has been in short covering mode.  There was a markets survey that indicated the active trading participants in the treasury market were extremely short (by over 30% which is huge) a full week before the NFP data was released, and the short position continued to build as we approached NFP.  The NFP number was strong (+200k jobs) and so the mkt immediately repriced lower as you would expect.  However, the important piece of information was not the NFP number...no, the important information was the mkt's aggregate position (very short going in), because in the end, it is positioning that drives trading activity.  So, what would you expect this large community of shorts to do after the market dropped in their favor because of the strong NFP data?  If you said "cover their short by buying the market," then you would be correct. 

Normally (in the past), this type of short covering event would take place in a single day.  However, because this net short position took multiple days to develop (since Dec-1), and was so widespread (not only was the short position large in size...but it was large in the number of participants that were involved), the following short covering rally has taken a full 4 days to work thru the market.  I can say with confidence that now, that large short position has mostly been covered.  This does not mean the market is long...this just means that the market no longer has an embedded short position that needs to buy to cover.  

From all our lessons on market behavior, we know that when the last short covers (is done buying) the market stops going up (no more buying) and falls back down to around where it all started.  I think we've just about seen that.

So, the question to ask is "now what?"

Tomorrow we have the 30yr bond auction, and next week the 2yr, 5yr and 7yr auctions.  So, the market will need to reset those shorts to absorb the upcoming supply.

I could say a bunch of other fluff to fill space, but that really is all there is to it.  The mkt must have a certain amount of short position embedded to make room to buy the supply (auctions), and so, i expect a pop in the market to be sold to facilitate that supply process.  If the market does not "pop," thereby not enabling the market to get short again, then i expect last minute setup selling, and perhaps another tail in the 30yr auction tomorrow.

That's about all the strategy I have for now.  Levels will be available on the private twitter stream.

-govttrader

US Treasury 30yr Auction Post-Mortem

Today the treasury auctioned off 16bln 30yr bonds at 1pm (ET).  This occurred during a fairly volatile backdrop.  Janet Yellen was answering questions from the Senate for much of the "setup" period.  Her testimony was fairly QE - supportive, and so the bond market rallied during her entire testimony.  Then we had a 3.5bln 10yr POMO @ 11am (ET) 2 hours before the auction.  This was the pre-auction crescendo that many day traders are familiar with.

Bonds rallied right into the 20minute period after the 10yr POMO in a crescendo of volume....and then fell back down to the overnight VWAP after the 1pm 30yr auction tailed 1.5 basis points.

(pictured are 30yr UB futures vs inverse DX futures)

I suggested selling bonds at 11:20am this morning into the crescendo of volume, and covering after the auction.  As a trader, i couldn't really think of anything else to do.

Up until the 10yr POMO, the 10/30 curve was stable at 108 basis points.   This indicated that a concentrated short setup had not taken place.  However, after 11:20am, 30yr bonds started to underperform (both outright price and on the curve), indicating that the setup (selling bonds pre-auction) had begun.  I thought the timing of this setup selling very coincidental.

While the treasury market is still generally strong post-auction (the belly inparticular), the fact that the 30yr auction tailed indicates that the large short base pre-Yellen speech release has mostly covered and the market should be fairly stable in the current price range.

 (UST yield change on day)

Typically, the treasury market builds a concession pre-auction, and actual investors of US Treasury paper buy these auctions to get long.  Today that is a scary trade (getting long) because the market has repriced higher after Yellen's early-release speech last night.

As a day trader, i won't participate in that trade...but as a portfolio manager, i'm sure that many are.
 With Janet Yellen at the helm, its clear that the economy will need to clearly demonstrate deep economic strength before she will consider reducing QE...and that may be a long time away.

If you are interested in this type of bond market commentary intraday, in addition to following along with the trades that i am doing in the market, then i suggest trying out my paypal subscription twitter feed.

-GovtTrader

UST 30yr Pre-Aution Thoughts Before Yellen Confirmation Hearing

On any other 30yr auction day, i would be selling 30yr bonds right here (9am in NY) (30yr bond yield @ 3.79% and UB futures @ 140-21   both higher in price by 4 basis points on the day) in anticipation of the 16bln 30yr bonds (32bln 10yr equivalents) to be auctioned in 4 hours.

(pictures 30yr UB bond futures vs inverse DX)

However, today is not any other day.  Unemployment claims are slightly up...more than expected, labor productivity is up, and unit labor costs are down.  All of these point to no desire to increase hiring.  That is bad for the consumer (because the consumer is labor), and hence bullish for bonds.  These numbers ought to also be bearish for stocks (a weaker consumer does not increase sprnding)...but it seems the QE fever is still keeping S&P futures high before the open.  In a world where more QE = higher stock prices...Yellen's prepared remarks released yesterday made no mention of taper, and were highly supportive of QE continuation (though she did not explicitly state that).  The remarks were vague, but erred on the side of continuing current accommodative policy (so, QE-4-ever).

This causes a conundrum. Regardless of Yellen's testimony and Q&A session this morning, there will still be a 30yr bond auction at 1pm (ET).  Given the strength and low volume yesterday, and the current bullish tone of the bond market (4bps stronger from yesterdays closes) the bond market does not feel like there is a significant setup of short 30yr positions.  This must take place before the auction.  Primary dealers must each bid for their pro-rata share of the auction (so about 800mm each).  No dealer wants to come out of a 30yr bond auction long 800mm 30yr bonds...its just too much risk in a world where directional risk is shunned.

This is the backdrop in the minds of bond traders as we approach Yellen's testimony and Q&A session.  We will be reacting to her testimony with this in mind.  However...to be clear...if she does not indicate a desire to extend QE (either in fact, or by indicating a lower unemployment threshold) then there should be good selliing of 30yr bonds to setup for the 1pm 30yr bond auction.

Typically, bond traders want to come out of the 30yr bond auction long bonds...but typically that occurs from a very low price, as the market usually sells off going into the auction.  Today that is not the case (so far).  I expect today to have unusually high volatility in the bond market....but we will just have to wait and see.

I'll be active on twitter today...so feel free to join in the conversation.


-GovtTrader