Bond Trader Makes Huge Bet on U.S.-Germany Yield Curve Reversals

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(Bloomberg) -- Someone in the global bond market is betting that the widening rift between yield curves across the Atlantic can’t last much longer.

A flurry of massive trades Wednesday in European and U.S. interest-rate futures caught the market’s attention both for their sheer size and their somewhat unusual cross-country bet. Taken together, they form a “box trade,” that pays off if the Treasury yield curve from five to 10 years stops flattening, while the German one avoids further steepening.

The timing of the wager comes a week after the U.S. curve flattened to 12.3 basis points, the lowest since 2007, and just days after the German counterpart closed at the widest level in two months. The spread between the two curves rose to 48 basis points on Monday, the highest since January and approaching levels not seen since 2000.

In one fell swoop after the block trade was struck, the U.S. curve steepened to session highs while the German curve flattened to the day’s lows.

While the motivation will remain murky at least until CME Group releases open interest data for the session on Thursday, the magnitude of the trade signals strong conviction. In total, the position equates to a staggering duration risk of $4.7 million in DV01 terms, or dollar-value per basis point move.

The trade contained a handful of individual parts, adding up to a bet that the 5- to 10-year Treasury curve would steepen against the equivalent Germany spread. It consisted of 100,174 five-year U.S. note futures and 63,887 10-year futures against 65,362 bobl futures and 29,145 bund futures. It could be an unwind of a current position, or a trader establishing new risk.

The trade comes ahead of Thursday’s European Central Bank policy meeting. It’s expected to be a quiet affair: just two basis points worth of a rate hike is priced into ECB-dated overnight index swaps. Meanwhile, the Federal Reserve, which meets next week, has already increased its benchmark rate once this year, and more than two additional hikes are priced in for 2018.

Whoever made this wager would benefit from Mario Draghi and ECB officials turning more hawkish than the market expects. It would also help if Fed Chairman Jerome Powell deviated from the central bank’s tightening path.

Neither of those scenarios are expected as of now, of course. But that’s why the trade is so eye-catching.

©2018 Bloomberg L.P.

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