Back-Door Bearish

- Neutral Duration — 10yr Treasury yields are more than 30bp below our view of fair value, but we are cautious due to strong momentum.
- Bearish Bias — We are long TIPS breakevens and short the 5yr Treasury fly, trades we expect to perform best in a move higher in Treasury yields.
- 10-30 Treasury Curve Volatile, but Fair — Despite high volatility, the 10yr-30yr Treasury curve appears fair given changing Fed expectations and moves in implied volatility.
- Strong Yen, Limited Rate Effect — Japanese insurance and pension funds will likely increase their foreign securities holding due to the strengthening Yen versus the US dollar. However, the move should not have any significant effect on US Treasury yields.
- Sell Fannie 4.5 Fly — We recommend selling the Fannie 30yr 4.5 fly as we expect prepayment speeds on Fannie 4.5s to increase substantially over the next few months. In our view, this large increase is not priced in.
- Agency Debt — With high negative convexity and tight yield spreads to bullets, investors should seek quality yields in the callable agency sector. 4nc1 and 5nc1 callable agencies provide a good balance between reduced negative convexity, reasonable OAS and yield.
- US Rate Strategy Model Portfolio — The portfolio is down 0.1% month-to-date.


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