The delivery squeeze in the June 10-year futures contract is shaping up to be one of the worst squeezes in recent history, according to bond market participants. Squeezes, which occur when there is more open interest than the cheapest-to-deliver securities available to fulfill these contracts, have become more frequent and severe as the hedge fund boom has caused open interest to zoom, said Tom Tucci, head of fixed income at Mizuho Securities.
Open interest in the 10-year contract was unusually large at $140 billion as of May 25, with only $24 billion available of the February '12s, the cheapest-to-deliver bond. The bond was also trading 250 basis points richer than it would normally in the repo market, a sign of how desperate investors are to buy the bond. In addition, the 10-year contract itself is 12 ticks richer than fair value as investors rush to buy the contract to take advantage of the squeeze. The contracts are significantly rich compared to the June five-year contract, which is only five ticks rich but has also been in hot demand.
While a few weeks remain until settlement, this squeeze could become one of the top three in the last 18 years, according to Gerald Lucas, chief Treasury and agency strategist at Banc of America Securities, referring to the time he's been in the market. The squeeze could lead counterparties to deliver the next cheapest-to-deliver on a large scale.
And this is exactly what some investors are hoping for. By holding the futures contract and the cheapest-to-deliver security, they are hoping they'll receive the next cheapest-to-deliver bond, the August '12s, which would net them 40 ticks of profit. But with the contracts themselves so rich, investors stand to lose 12 ticks if they receive the cheapest-to-deliver bond.
Market participants speculate the continuing squeezes may cause the Chicago Board of Trade to change its regulations, such as possibly limiting the number of contracts one investor can have. Melissa Jarmel, CBOT spokeswoman, declined comment.
