The inversion of the 10-year Treasury futures curve may foreshadow a cycle that repeats or is more pronounced than the richness of the June cycle. While contracts further out the curve generally trade cheaper than the near contract, the September 10-year Treasury futures are trading richer than the June contracts.
The inversion has resulted in a similar inversion in the nominal curve: the August '12s, the cheapest-to-deliver security for the September contract, were trading six basis points richer than the February '12s, the CTD security for the June contract. In addition, the August '12s are trading 255bps richer than general collateral, far richer than in a normal scenario.
The fact the September contract is so rich so early in the cycle may foreshadow it will be even richer than the June contract, according to Greg Elders, government strategist at Merrill Lynch. The richness of the contract would also mean even greater demand for the August '12s.
The inversion in the 10-year Treasury futures curve began when investors shorted the June contract as inflation fears rose in April, according to Osafumi Takizawa, account executive at O'Connor & Co, a futures broker. Then, as the idea the economy was going through a soft patch gained ground, investors rushed to cover their shorts by buying the September contract. More recently, speculative players have piled into the trade and accentuated the volatility in the spread trade pricing, he said.
As a result of the increased volatility, the Chicago Board of Trade has required investors wishing to trade the so-called calendar spread (for example, shorting the June contract and being long the September contract) to put up money as a guarantee they'll complete the transaction. The margin required to trade a 10-year calendar spread is much higher than for other maturities because of the volatility.
One result of adding the calendar spread margin would be to lower the open interest because it effectively ties up funds investors could employ elsewhere. But the open interest for the June, September and December contracts have remained steady at 1.95 million contracts since the CBOT implemented the change. This could signify day traders are running up the volatility because they would not be subject to the new margins if they settle their trades before the end of the day, according to Glenn Dulieu, a Treasury trader at Mizuho Securities.
Maria Gemskie, CBOT spokeswoman, declined comment on whether the CBOT will take further steps to lower volatility.
