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Paratrade Systems Weekly Research News

9 Feb

European Bond Connections

Q1: How much do European rates help US bond prices?

Quantitative easing is over in the US but it continues in Europe. When US bond prices got smashed last November European bonds performed much better. This was no surprise as the fear of new import duties was (is) purely an American problem. Over the last year European bonds have significantly outperformed. Can we say that US bonds are pulled higher by rising German Bund prices?

Euro Cousins 1

The correlation is clearly very high (no surprise). I want to see how well the Paratrade bond market Fuel Gauge does to predict future Bund prices. The next chart shows the cumulative number of points gained in plot #2. The filter made more money in Bunds than in US 10’s but all of that outperformance came as a result of the superior rise in Bunds over the last two years.

Euro Cousins 2

How much does a rising Bund market help the US bond market?

We shall add to the fuel gauge filter a test to see if Bunds are rising. It will certainly reduce the number of trades we shall get in a rising market (not good) but we can look to see if the success rate is higher and the equity curve is better:

Euro Cousins3

Adding the Bund test eliminates virtually all our gains! It also failed to protect us during sell-offs. It doesn’t matter what the lookback period is for the momentum function. In fact, it’s better to buy US bonds when Bund momentum is negative as we can see below:

Euro Cousins4

The reason why this is true is because we get better entry prices if we wait for a price pullback and yet still have very high fuel gauge readings. The number of trades is lower so the total gain is also lower but the equity curve is very attractive. Unfortunately using this momentum test on Bunds produces indistinguishable results from using the same test on US bonds.

Is it better to wait for US bonds to be cheap versus Bunds?

No. We can use a trend-adjusted spread to make sure that US bonds are cheap (or not one standard deviation rich) versus Bunds. These provide no added value. They might if we were going to short Bunds at least partially against our US bond long positions but there is no added alpha or market upside just because US bonds are cheaper than their European counterparts.

Conclusions:

  1. Bund prices provide no additional information that helps us find or filter for more reliable trend or entry points to trade US bonds.
  2. Our bond fuel gauge gives signals for Bunds that are at least as valuable as they were for US bonds.
  3. Buying on weakness when the gauge is high, yields better returns than waiting for momentum (trend) to confirm direction.

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