The U.S. Treasury yield curve, as measured by the difference between the 2-year and 10-year bonds inverted at the end of August only to steepen sharply at the beginning of September before collapsing post the FOMC meeting and is re-steepening again as economic data has shown signs of weakness across both manufacturing and services. Just as trick-or-treaters seek out the house offering full size candy bars and avoid the one offering raisins, traders may want to consider the possibility for the October meeting to be either a trick or a treat as the potential for both positive and negative outcomes has increased.

Source: Bloomberg Finance, L.P., as October 11, 2019. Past performance is not indicative of future results. One cannot invest directly in an index.

More Cuts to Come?

FOMC members continue to emphasize that the most recent cuts are a mid-cycle adjustment as in 1995 and 1998, but the business cycle may not allow them to do only that, as the outlook for the longest running US expansion continues to face headwinds from the lingering impact of Chinese deleveraging and structural challenges in the Eurozone, to more topical ones like the ongoing trade negotiations and Brexit.

Slow Growth. Low Inflation.

For now, the US economy is still growing, but that growth is slowing; however, it is not yet so poor that job growth has seen major impact. What may be more concerning is inflation expectations. For some time, inflation has not moved as expected likely for structural reasons, making investors not require compensation for the risk of capital loss thanks to rising prices. This has been reflected as a persistently negative term premium. Simply put, a negative term premium means that investors are not requiring excess yield to hold longer-term debt as opposed to rolling over shorter-term debt. In addition, the tariffs are proving disinflationary as they move to a wider range of industrial and consumer goods.

Credit Spreads

Another question mark is the credit markets. At the index level, credit spreads look benign, but the spreads of the lowest quality, weakest credits remain stubbornly high, indicating that credit risk may be higher than expected. The lasting underperformance of US small caps relative to large cap reflects this as well. As long as this remains the case, there will continue to be isolated downgrades and bankruptcies, but it looks far from a widespread credit event thanks to companies having been able to refinance their debt as corporate cash flows have remained positive. Of course, the potential for additional downgrades, as was seen with Ford, remains high due to BBBs being 50% of the investment grade debt market.

High Yield Spreads Remain Wide 

Source: Bloomberg Finance, L.P., as October 11, 2019. The data represents the difference in yield between bonds of various credit quality. Past performance is not indicative of future results.

The heightened uncertainty on the path of interest rates provides traders with ample opportunities as evidenced by the recent rise in the index that measures volatility in the Treasury markets.

Volatility Rises for Treasurys

Source: Bloomberg Finance, L.P., as October 11, 2019. The data represents the movement in U.S. Treasury yield volatility implied by current prices of one-month over-the-counter options on 2-year, 5-year, 10-year and 30-year Treasuries. Past performance is not indicative of future results.

Cuts. How Deep?

So what, are the largest opportunities out there for hawkish or dovish positioning?

A moderately hawkish outcome is more likely what traders could see. The markets are pricing in additional cuts in 2019 – likely as soon as October. This cut would be consistent with the mid-cycle adjustment of 1998. Any more than that would risk a loss of credibility by the Fed and potentially spook the markets, which is why even if the cut comes this month, policy makers will likely continue to emphasize underlying economic strength even if uncertainties are growing. This could likely see a repeat of September which would cause the yield curve to flatten as the long bond comes down.

On the other hand, the FOMC could surprise with a 50 bps cut along with the reintroduction of quantitative easing, even if they do not call their T-Bill buying program that. This would likely be what finally sees the US Dollar weakened against major currencies; although, monetary policy in Europe and Japan will remain easier than the Fed, so the move may not last, making this more of a trade than an investment. We would also see short-term yields collapse and the yield curve steepened sharply.

Related Leveraged ETFs

These leveraged ETFs seek investment results that are 300% of the return of its benchmark index for a single day. Investing in a Direxion Shares ETF may be more volatile than investing in broadly diversified funds. The use of leverage by an ETF increases the risk to the ETF. The Direxion Shares ETFs are not suitable for all investors and should be utilized only by sophisticated investors who understand leverage risk, consequences of seeking daily leveraged investment results and intend to actively monitor and manage their investment.

Direxion Shares Risks – An investment in each Fund involves risk, including the possible loss of principal. Each Fund is non-diversified and includes risks associated with the Funds’ concentrating their investments in a particular industry, sector, or geographic region which can result in increased volatility. The use of derivatives such as futures contracts and swaps are subject to market risks that may cause their price to fluctuate over time. Each Fund does not attempt to, and should not be expected to, provide returns which are three times the return of their underlying index for periods other than a single day.

An investor should carefully consider a Fund’s investment objective, risks, charges, and expenses before investing. A Fund’s prospectus and summary prospectus contain this and other information about the Direxion Shares. To obtain a Fund’s prospectus and summary prospectus call 646-760-7101 or click here. A Fund’s prospectus and summary prospectus should be read carefully before investing.

Direxion Funds Risks – An investment in the Funds involves risk, including the possible loss of principal. The Funds are non-diversified and include risks associated with concentration risk which results from the Funds’ investments in a particular industry or sector and can increase volatility over time. Active and frequent trading associated with a regular rebalance of a fund can cause the price to fluctuate, therefore impacting its performance compared to other investment vehicles. For other risks including correlation, compounding, market volatility and risks specific to an industry or sector, please read the prospectus.

Direxion Shares Risks – An investment in the ETFs involves risk, including the possible loss of principal. The ETFs are non-diversified and include risks associated with concentration that results from an ETF’s investments in a particular industry or sector which can increase volatility. The use of derivatives such as futures contracts and swaps are subject to market risks that may cause their price to fluctuate over time. The ETFs do not attempt to, and should not be expected to, provide returns which are a multiple of the return of their respective index for periods other than a single day. For other risks including leverage, correlation, daily compounding, market volatility and risks specific to an industry or sector, please read the prospectus.

Hong Kong Investors -This website and the investment products referenced herein (“Website”) are directed to persons who are “Professional Investors” within the meaning of the Hong Kong Securities and Futures Ordinance (Cap. 571) (“Ordinance”). This Website is not directed to the general public in Hong Kong. You agree that your use of this Website is subject to you reviewing and acknowledging the terms of this disclaimer and the website’s terms of use. Information herein is not intended for Professional Investors in any jurisdiction in which distribution or purchase is not authorized. This Website does not provide investment advice or recommendations, nor is it an offer or solicitation of any kind to buy or sell any investment products. Direxion Asia Limited (“DAL”) is licensed with and regulated by the Securities Futures Commission of Hong Kong (“SFC”) (CE Number: BAZ386) to provide services to Professional Investors. DAL does not maintain nor is it responsible for the contents of this Website, which has not been approved by the SFC. DAL is an affiliate of other companies within the Direxion Group companies which may manage the products and provide the services described herein, which are not directed to the general public in Hong Kong. Companies within the Direxion Group which do not carry out regulated activities in Hong Kong are not subject to the provisions of the Ordinance. Foreside Fund Services, LLC is the distributor for the Direxion Shares in the United States only.

Distributor for Direxion Shares: Foreside Fund Services, LLC.
Distributor for Direxion Funds: Rafferty Capital Markets LLC.

Direxion © 2010 – 2019

Subscribe to our free daily newsletters!
Please enter your email address to subscribe to ETF Trends' newsletters featuring latest news and educational events.