Treasury Arbitrage Traders Can’t Wait for Fed to Start Tapering

(Bloomberg) -- U.S. government-bond traders can’t wait for the Federal Reserve to stop buying Treasuries. They’re looking forward to the return of trading opportunities that tend to disappear when a central bank is hoovering up $80 billion a month.

Since its purchases of Treasuries stabilized at that rate in June 2020, traders have focused on which notes and bonds the Fed was likely to buy, since owning those could be profitable. 

But the sheer magnitude of the Fed buying squeezed much of the cheapness out of the market. The central bank’s Treasury holdings have more than doubled since March 2020 to $5.4 trillion, nearly a quarter of the debt outstanding. Opportunities to profit from relative-value trading -- taking positions in bonds that appear temporarily cheap or rich -- became scarce. 

That’s already beginning to change, according to Morgan Stanley, even though the Fed has yet to announce the start of tapering. The bank’s Treasury Relative Value Opportunity index “has started to rise from depressed levels, similar to how it started rising in 2013 around the taper tantrum, as the market priced in less involvement from the Fed,” strategists led by Matthew Hornbach said in a note last week.   

“The more dispersed these bonds are, the more relative value opportunities exist,” they said. The biggest divergences are appearing in the 8- to 10-year and 20- to 30-year segments of the market, the strategists found. 

After the Fed’s last monetary-policy meeting on Sept. 22, Chair Jerome Powell said tapering could begin as soon as November and end by mid-2022. For relative-value traders, the sooner the better.

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