Debt Ceiling & Fed

Debt Ceiling & Fed

Tomorrow the Fed will conclude its meeting. It's expected for them to cut back on some of their asset purchases – even if little, this will likely cause some volatility in markets. Tomorrow may present a great opportunity to use weekly options that are a cheap way to benefit from outsized movement.

As of 8/1/2021, the US Treasury is once again at the debt ceiling. With no sign of resolution anytime soon, the Treasury will need to resort to “extraordinary” measures to pay its Bills and obligations.

During the last few times there's been a debt ceiling “lockup”, bond yields tend to fall (prices up).

The last 2x times we were in this predicament was March 15, 2017, and then again March 1, 2019. Notice how Bond Futures fell with an increase to the debt ceiling?

Something else we can use here is the Volatility Visualizer. We can use it on either TLT or on /ZB.  This tool shows us the Expected Move of any stock, futures or ETF.

What do we see? Take a look at the labels. Look at the upper right corner of the chart, there’s a label that says “CLOSE IN”… /ZB Futures contract has closed within it’s Expected Move 68% of the time going back 5 years

Now let’s look at the same chart but instead of /ZB Futures, we are looking at /ES Futures. Over that same time period of 5 years the /ES futures closed within the Expected Move over 87% of the time. That’s a big number!

For weekly options this data is even more compelling. In the two charts below we look back 5 years at the weekly options data (as opposed to the Monthly above). Now we see /ZB Close In it’s weekly range 68% of the time, while /ES closes within it’s Weekly Expected Move 87% of the time. That’s incredible.

This boils down to telling us that /ZB options are far better priced for the buyer than are options on SPX or /ES. Options on the SPX (or /ES) these options are better for “sellers” when we look at these statistics. 

Thus for the upcoming weeks, We will very much like the purchase of options on /ZB, with a bias to the upside given all of the above.

This is the most important part

Are banks doing this to earn a measly 0.05% on their cash, or to get access to those treasuries so that they can then be used to fund bank balance sheet capacity in the repo market? My bet is on the latter. 

There's a collateral crunch. And with Treasury auctions coming to a haut until further notice, I believe bonds will defy everyone's inflation fears and keep rising in price. All due to the demand for this pristine collateral. 

Thanks for reading! 

Jonathan Rose


Get Trade Ideas, Live Class, Expert Support & Community Access​

Masters in Trading Community

Masters in Trading Community is our monthly membership that provides you with the trades that matter. Get trades delivered weekly, find the support you need from a live Q&A session and rely on the guidance and support of a vibrant and exclusive Discord community.