The Next Big Risk for U.S. Treasuries: A Futures "Technical Switch" Could Amplify the Next Selloff

PANews, October 6 – According to a Financial Post report, the U.S. 30-year Treasury yield is approaching 6%, and the next bout of volatility in the bond market may not come only from the spot market. A technical rule in U.S. Treasury futures contracts is becoming a potential amplifier of further upside in long-end Treasury yields.

U.S. Treasury futures are widely used to hedge government bond positions and are also an important tool for leveraged funds pursuing strategies such as the "basis trade." Futures prices typically track the cheapest bond in a basket of deliverable Treasuries, known as the "cheapest-to-deliver" (CTD) bond. The problem is that when yields rise rapidly, the pricing relationships within the deliverable basket also change. The CTD may therefore shift to longer-dated Treasuries, triggering what is known as a "CTD switch" and forcing investors to readjust their futures positions.

BNP Paribas strategists Guneet Dhingra, Sebastian Mauleon and Vincent Zhou said that a migration of the CTD toward longer maturities could "exacerbate the rise in long-end yields in the spot market." There is a technical rule in U.S. Treasury futures contracts: when long-end yields rise to a certain level, it triggers a wave of "forced selling of Treasury futures," and that selling could in turn push long-end yields even higher.