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Thursday, September 12, 2024

Stay Ahead: Long-Term Bonds and Futures Poised to Thrive as Interest Rates Decline

By Century Financial in 'Investment Insights'

Stay Ahead: Long-Term Bonds and Futures Poised...
Can Apple do AI, right?

U.S. Treasury Bond Ultra: Product Details

The U.S. Treasury Bond Ultra is a futures contract that tracks the price movement of the most recently issued 25-year and 30-year U.S. Treasury bonds. Investors can use it to hedge their risk against rising interest rates or to speculate on the direction of bond prices. Futures contracts for the U.S. Treasury Bond Ultra are available on both the Century Trade and TradeUltra platforms.

 
Contract Specification
Underlying U.S. 30-Year 6% Bond
Contract Size $100,000

Source: Bloomberg
Date: 2nd September 2024

 

Fed: The Path Ahead

At the July FOMC meeting, the Federal Reserve maintained its interest rates at 5.25% to 5.5%, aligning with expectations. Moreover, at the recent Jackson Hole symposium, Fed Chair Jerome Powell hinted at a shift in monetary policy, marking a pivotal moment in the central bank's inflation fight. The market is now eyeing a deflationary trend, with the job market moderating. Inflation has notably decreased, falling from a peak of 9.1% in June 2022 to 2.9% year-over-year in July 2024. Although still above the Fed's 2% target, uneven disinflation is evident in recent economic data. Additionally, Q2 2024 GDP growth accelerated to 3.0%, while core PCE inflation dropped to 2.6% year-over-year. Consumer spending continues to outperform forecasts, signaling robust economic health with growth above trend. A 25-basis-point rate cut is widely anticipated for September, though the Fed remains cautious, with the upcoming jobs report which can possibly call for a larger 50-basis-point reduction, supporting the outlook for U.S. Treasury Bond Ultra.

 

Euro Buxl: Product Details

The Euro Buxl futures are a natural complement to the EU bonds market , offering traders and investors a direct means to manage their long-term interest rate risk and portfolio duration. Euro Buxl futures ("Buxl”) consist of cash Euro bonds with at least 24 to 35 years of remaining term to maturity. This product is available on the Century Trader platform under the description “Euro Buxl - Cash” and the Ticker “EUROBUXL.”

 
Contract Specification
Underlying U.S. 30-Year 4% Bond
Contract Size EUR 100,000

Source: Bloomberg
Date: 2nd September 2024

 

Euro Buxl: Product Details

In its most recent meeting on July 18th, 2024, the European Central Bank opted to maintain interest rates at 4.25%, aligning with market expectations. Looking ahead, the latest Eurozone CPI report revealed an inflation rate of 2.2%, meeting the forecasted figure of 2.2% and down from the previous month’s 2.6%.

A key area of concern for ECB policymakers remains to be services inflation, which despite being the most persistent pressure, saw a slight deceleration in the month of July. Economists suggest that this moderating decline in services inflation may be sufficient for a rate cut in September, which is currently viewed as the base case scenario by many economists. As of now, market participants are pricing in a 99% likelihood of a rate cut in the upcoming September meeting.

Overall, economists anticipate that inflation will continue to moderate, paving the way for potential interest rate reductions. This outlook supports a positive sentiment for Buxl prices, as easing inflation and lower interest rates typically bolster bond markets.

 

Euro Buxl

Regression Analysis

The model below forecasts the Euro Buxl’s price movement when the 30-year German government yield changes.

As of 3rd September 2024, the regression equation over two years is as follows:

Y = -29.522 X + 209.724

The standard deviation of error is 1.250, and the study assumes a 90% confidence interval.

 
Scenario Analysis
Change in Yield Estimated German 30-Year Government Bond Yield Estimated Euro-Buxl Price Estimated % Change in Euro-Buxl's Price
Current Levels 2.51% € 134.44 Base Case
Yield Decreases by 50 bps 2.01% € 153.60 14.26%
Yield Decreases by 100 bps 1.51% € 168.37 25.23%
Yield Increases by 50 bps 3.01% € 124.08 -7.70%
Yield Increases by 100 bps 3.51% € 109.32 -18.68%

Source: Bloomberg
Date: 3rd September 2024

 

The table above demonstrates the inverse relationship between the Euro Buxl’s price and the 30-year German government bond yield. If the yield declines by 50 bps to 2.01%, the bond price is projected to rise to €153.60. Conversely, if the yield increases by 50 bps to 3.01%, the bond price is expected to fall to €124.08.

 

U.S. Treasury Bond Ultra

Regression Analysis

Regression analysis is a useful tool for assessing the strength of relationships between different variables and modelling how these relationships will evolve in the future. The model below forecasts the movement in the T-Bond Ultra’s price when the 30-year U.S. government yield changes.

As of 3rd September 2024, the regression equation over two years is as follows:

Y = -20.067 X + 214.017

The standard deviation of error is 1.326, and the study assumes a 90% confidence interval.

 
Scenario Analysis
Change in Yield Estimated U.S. 30-Year Government Bond Yield Estimated T-Bond Ultra Price Estimated % Change in T-Bond Ultra
Current Levels 4.13% $132.25 Base Case
Yield Decreases by 75 bps 3.38% $149.53 13.07%
Yield Decreases by 150 bps 2.63% $164.58 24.45%
Yield Increases by 75 bps 4.88% $119.43 -9.69%
Yield Increases by 150 bps 5.63% $104.38 -21.07%

Source: Bloomberg
Date: 3rd September 2024

Risks and Assumptions related to Back-tested trading strategies
The risks and assumptions listed here are not intended to be an exhaustive summary of all the risks and assumptions involved.
The strategy might suffer from look-ahead bias which occurs due to the use of information or data in a study or simulation that would not have been known or available during the period being analyzed. This can lead to inaccurate results in the study or simulation.
Future price movements may not be exactly the same as the historical price movements and this could lead to variation in performance.
Testing can sometimes lead to over-optimization. This is a condition where performance results are tuned so high to the past they are no longer as accurate in the future.
The model assumes no slippages in trading. Slippage refers to the difference between the expected price of a trade and the price at which the trade is actually executed.
The back-tested strategy might be at risk of data dredging, which is the behavior of testing multiple hypotheses at one time, resulting in picking the data that best supports your main hypothesis.
Drawdowns in actual trading can be higher than the tested system and losses could be significant in the event of leverage.
Unforeseen events can lead to variation in performance from the tested trading strategy.
The tested result has been computed with price feeds available from Bloomberg.
The testing environment has not considered transaction or any other costs.
Trading indicators used for the purpose of testing has been provided by Bloomberg.
The strategy might suffer from data mining fallacy, selection bias and backfill bias.
A trading strategy that performs well on multiple datasets from one market (e.g., forex) might not perform as well in another market (e.g., stocks).
The strategy may not depict accuracy in terms of spread changes due to the spread-widening events.

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