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Author: trptrade Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35400  
Subject: Re: ok, Professor Yieldinator, what's this mean? Date: 1/25/2010 7:34 PM
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"The amount of open interest in the March treasury futures contracts is down. For the 30-year bond, it real low. The black line shows the averages, the blue shading shows 'historical ranges', etc."

"So, ...?"

Fun questions.

Treasury Futures (US, CBOT) that you are referring to can be resolved by delivering any instrument that is 15-year or higher duration. "The key feature distinguishing the Ultra T-Bond from the existing T-Bond futures contract is the relatively narrow range of deliverable securities. The deliverable basket for Ultra T-Bond futures comprises cash Treasury bonds with at least 25 years of remaining term to maturity. By comparison, deliverable securities for the existing T-Bond contract are bonds with remaining terms to maturity of 15 years or more" (source: http://www.cmegroup.com/trading/interest-rates/ultra-tbond-f... ). Starting January 11, 2010, a new futures contract was available (Ultra T-Bond). This would naturally reduce volumes on the traditional T-Bond futures contract for those that want the exposure to longer duration. This reduction is small, but it does close what appears to be slightly more than half the gap to the bottom of the historical range.

Second, since reduced open interest in futures tends to imply more volatility in the underlying bond, one could infer is a reflection that people are less certain about the outcome of bond pricing. This is consistent with the mixed economic signals we are seeing. Interestingly, this is not consistent with current intra-day pricing of long-term bonds, which are not all that volatile on a statistical basis. However, interest rate options show the opposite - interest rate volatility is still at very high levels: http://www.bloomberg.com/apps/cbuilder?ticker1=BBOX%3AIND ... look at the 5-year graph. Therefore, there is not daily volatility, but there is what appears to be significant unknowns/uncertainty left to be resolved (jobs data, corporate earnings, etc. etc.) between now and the end of March that will impact the prices and thus drives implied volatility.

Third, through arbitrage, the futures market can act as a price discovery mechanism for the cash treasury market. This price discovery mechanism of the futures market will naturally be strengthened when the underlying item is in short supply, and naturally weakened when the underlying item is in plentiful supply. (With a narrow spread, you don't need a futures market to do price discovery.) It should therefore follow from the large supply of longer term bonds that the Treasury is putting on the market (somewhat different than the strategy they were on early in the crisis and significantly more than they have issued in a long time) that it would drop the influence of futures as a mechanism for price discovery (rather, traders would participate in the cash market). This would thus drop potential value of participating in the futures market, reducing volumes.

There are potentially other reasons (e.g. arbitragers not actively involved because they can't afford it or it isn't worth it, potential yield curve flatness driving delivery uncertainty [Note there was also a large drop in open interest in 2000 as the yield curve inverted (relative to '97-'99 where it was 'normal')], and potentially even some 'distortion' of historical time value of money due to today's effectively zero short term rates [0.06% for 3 months]), but I would hazard that the three items above serve as major reasons.

Tom
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