5-30s Steepener

The nonfarm payrolls numbers disappointed the jobs data optimists with a huge miss from consensus.  You can expect more of the same until the crowd catches up with the elephant in the room:  people are choosing to be unemployed.  When you get a $600-$700 unemployment check ($300 federal + another $300-400 state unemployment benefits) every week for pretending to look for a job and you only make marginally more working 40 hours per week doing menial, tedious jobs, its an easy choice.  You have freedom, no Rona risk, no stress, and $600/week for watching Netflix, Youtube, ESPN, playing video games, trading stocks on Robinhood and Ameritrade, etc.  

There is an abundance of workers.  And they will start taking up jobs once the federal unemployment bonuses expire.  But not until then.  Don't blame the workers and call them lazy, they are making rational decisions based on government policies.  Blame the government.  This isn't just Democrats.  This also applies for Republicans, who signed off on everything last year, including the $600/week federal unemployment bonuses which were even more egregious. 

The US government is incompetent and inefficient.  There is so much waste that the only way the government can get any kind of economic results is to just throw trillions at it.  Brute force money.  So that's what's happening with unemployment benefits.  They are throwing money at the problem, and all it is doing is making it harder for businesses to find workers, especially lower skilled labor. 

So the knee jerk reaction to the big NFP miss was to assume that the economy isn't as strong as we thought it was, and to aggressively bid up bonds, especially short duration Treasuries.   You get a lot of information on days like Friday because you see what trades the hedge funds are clamoring to when they add risk.  The 5-30s curve steepener is the most popular fixed income trade among the hedge funds.  You can see this clearly when the funds, usually waiting for an event (FOMC meeting, NFP) to finish before adding to their position.  And the funds going to work on Friday managed to push the long end to the negative even after such a big NFP miss and a spike higher in bonds afterwards. 

Basic theory goes like this:  bad jobs number ---> dovish Fed ---> further delay of rate hikes ---> more inflation.  So buy the 5 year Treasuries, which are more sensitive to rate expectations, and sell the 30 year Treasuries, which are more sensitive to inflation.   

The hole in this theory is that the fixed income market isn't worried about jobs, its focused on inflation.  And even though the Fed is supposed to focus on employment and inflation, their 2 mandates, they really only have 1 mandate.  Let's get real.  Its to please the financial markets.  

So at some point, and we are getting closer and closer to that point, being dovish is not what the market wants, because the market doesn't want high inflation, and that is what the Fed is causing with their easy money policies.  And soon the Fed will get in tune with what the market really wants, which is tighter policy, because let's face it, the Fed are just slaves to the financial markets.  Both stocks and bonds.  That's probably when the short end of the yield curve will start to price in rate hikes more aggressively as the Fed starts to talk taper which in turn will get the market projecting a timeline for rate hikes. Probably starts happening later summer/early fall.

That is the fixed income pain trade.  A flattening of the yield curve, as the 5 year Treasuries start pricing in tighter monetary policy, with inflation expectations coming under control, keeping a bid to 30 year Treasuries.  Looking at the eurodollars futures speculator positioning, they've barely gotten started in putting on rate hike bets.  The positioning is neutral.  Based on how short speculators got in 2018, or even back in 2014 during the taper, the speculators (light blue line) aren't positioned for a eurodollars selloff.  

Eurodollars Futures COT positioning data

We are getting close to the infection point for the 5-30s yield spread.  I think its coming within the next 3 months, as the Fed gets closer to the taper.

SPX hit another all time high as the stock market expects the Fed easy money policy to go on even longer with the weak jobs number.  Bad news is good news forever.  It is the reality of the current financial markets.  The economy is of very little importance because it has no dynamicism.  Its moribund on its own so a static variable.  The only things that matter are fiscal and monetary policy.  So any data that increases the chances of easier fiscal and monetary policy is considered a positive for the stock market.  People are still unable to adjust to that reality, which has been ongoing for the last 10 years.  

I am still short SPX, small size, and looking to add when the time is right.