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50bp, Right on Schedule   The Dangers of Junk
Jan 30 2008 3:14PM EST

Treasuries: Steeper

Julian Robertson's big macro bet right now, according to Brian O'Keefe, is a curve steepener.

Here's the idea: In the fall, Robertson invested in a derivative called a "curve steepener" that allows him to be long the price of two-year Treasury and short the price of the ten-year Treasury - betting that the difference, or curve, in the yield between the two will increase.
The investment reflects a negative outlook on the prospects for the U.S. economy that has been building in Robertson for years. He believes that the Federal Reserve will continue to flood the economy with money, weakening the currency and ultimately causing the Japanese and Chinese central banks to stop purchasing Treasuries, which will drive the price of 10-year bonds down. It's a macroeconomic hedging strategy that has already paid off handsomely.
So far in 2008, the difference in the between the two bonds has already increased from 97 to 138 basis points. "I've made a big bet on it," he says. "I really think I'm going to make 20 or 30 times on my money."

Dean Baker notes that in the wake of the Fed's 50bp cut today, the yield on the 10-year Treasury bond rose by 5bp to 3.72%, 34bp higher than its lows earlier this month. Right now, with the 10-year at 3.71% and the 2-year at 2.21%, the spread between the two has hit 150bp, which means that Julian Robertson can probably afford another golf course or two.

I can see why Robertson loves this trade so much. The Fed seems set to cut even further, which will only serve to keep the yield on the two-year note depressed. But inflation isn't going away, and one should be able to expect a positive real return on the ten-year note - which, it's worth noting, was yielding more than 5% as recently as July.

If you are thinking about refinancing your mortgage, then, perhaps now's the time to do it. Long-term rates could be headed back up, even if short-term rates continue to fall.

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