UBS Securities' interest-rate strategist Mark Mahoney is arguing to firm clients that the recent sell-off on the short-end of the U.S. Treasury curve is presenting some excellent trade opportunities. Specifically, he is citing the fact that one can finance a two-year position in the repurchase market at 1.1%, versus the bond's current yield of 1.87% last Thursday, with forward notes trading at a nominal 2.68% yield. Using elementary bond math (i.e. 2.68-1.87), Mahoney reasons that the trader can lock in 81 basis points of carry over the next year. Moreover, he notes that any time forwards are trading 100 basis points over Fed funds futures, this has proven to be a historically very attractive trading environment. Last Thursday, the July '04 Fed funds future contract was trading at 1.66%. Perhaps most importantly, Mahoney says the transcript of the June FOMC meeting makes clear that the Federal Reserve is serious about maintaining rates at these levels.
And therein lies the rub forTony Cresenzi, chief bond market strategist of Miller Tabak & Co. who offers dissenting view of sorts. He acknowledges the cheapness of the short-end of the curve, but reasons that the 87 basis point differential between the two-year and the 1.0 % Fed funds rate "can easily move much wider." He supports this by pointing to March 2002, when the spread was 200 basis points. He says it is important to recall that the Fed's commitment to remaining "accommodating" does not extend to leaving Fed funds at 1.0%; indeed, as long as inflation remains "at or around" the Fed funds rate, then monetary policy can be said to be accommodating.