Best Trades of 2008: #2 Getting long and staying long the 30-year Treasury bond

Posted Dec 31st 2008 12:00PM by Bryan Perry
Filed under: Newsletters

This strategy went from being a modestly successful trade through October to a hero-sized trade in the past 45 days.

The Fed funds rate, the most widely followed interest rate the banks charge each other for overnight lending, topped out in August 2006, at 5.25%.

When the Fed started easing rates thereafter, no one at the economic think tanks forecasted anything close to what we are seeing today (namely a Fed funds rate of zero to 0.25% -- a decline of a full 5% in 17 months).

The decline in rates started out so orderly and coordinated that it seemed almost too good to be true, and the Dow Jones Industrial Average hit an all-time high, topping 14,000 for the first time in July 2007.

However, the quarter-point cuts gave way to a three-quarter-point cut, or 75 basis points, on Jan. 22, 2008, signaling that the Fed was seeing a material breakdown in the credit and housing markets. Following that seemingly radical rate cut, just eight days later on Jan. 30, the Fed again slashed the Fed funds rate by another half point, or 50 basis points, to 3%.

From there Bernanke & Co. held steady for a couple months to see if any good would come of their efforts.

When evidence of further erosion in the credit markets surfaced with the impending collapse of Fannie Mae (NYSE: FNM), Freddie Mac (NYSE: FRE), Indy Mac, Bear Streans and Lehman Brothers (OTC: LEHMQ), the Fed lopped another three-quarters of a point off the Fed funds rate, taking it down to 2.25% on March 18.

That was considered the absolute floor at the time, a level that would stick. But that wasn't the case.

As we all know now, the Fed's work wasn't done, and now overnight lending is right at or just above 0%. The history-making easing of the Fed funds rate set the table for the mother of all bond rallies in the Treasury market. For the first 10 months of 2008, the yield on the 30-year Treasury bond was range-bound, trading between 4.25% and 4.75%.

Then, come September, the yield cracked the 4.25% level and traded down to 4%, where many pundits called a top for bonds and a bottom for yields.

Boy, were they wrong.

Since Nov. 20, when the market averages hit their lows, the yield on the 30-year T-bond has plummeted to 2.5%, making this trade one of the big winners of 2008.

Bryan Perry is a contributor to OptionsZone.com.

Tags: 30-year Treasury bonds, 30-yearTreasuryBonds, best trades of 2008, BestTradesOf2008, bond yields, bonds, BondYields, bryan perry, BryanPerry, fed, fed funds rate, federal reserve, FederalReserve, FedFundsRate, interest rates, InterestRates, rate cut, rate cuts, RateCut, RateCuts, T-bond, treasury bonds, TreasuryBonds

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Reader Comments (Page 1 of 1)

12-31-2008 @ 1:52PM

NJSteve said...

So what is the best way for an individual investor to have traded this? There must be a better way than holding the actual bond. And when the rates reverse and start going back up, what is the best way to trade that?