Inside Operation Twist: Trading like the Feds

Here's a quote from a past article featured on this blog:

The treasury bails out troubled banks, while the Fed funds these bail outs by purchasing attractive treasury bills. The return on interest and added bank fees for insurance serves as revenue for the Fed, in which about 80% is given to the Treasury. So, I beg to question the motives of these politicians. I support Bernanke's fight to keep the Fed independent. -Dantes Outlook

Trading like the Fed during these times might involve something more sophisticated  than an average FX position. The dollar is busy saving investors from Europe, and in the long run the effects of Operation Twist will probably not be evident in the FX markets as conditions change frequently.

Look towards the financial futures market. Second in size to the global foreign exchange market (FX), the financial futures market trades at such massive scale equal to about 1/2 of US GDP. It is expensive to participate here (thousands of dollars) but positions are generally longer term and only trade about 4 times per week.

Here's a strategy: (NOTE -- currently studying this for my degree)

Implied yield on T-Bond contract is around 5.66%. Implied yield on Eurodollar CD is around 2.62%. Let's aim for the T-bond to get 50 basis points above the Eurodollar CD rate.

For this 50bp spread to occur, this needs to happen:

3.12% - 2.62% = 0.50%  long term (or 2.62 + 0.5 = 3.12)
5.66% - 5.16% = 0.50%  short term

Thus, the T-bond futures contract will need to rise enough for the implied yield to fall to 3.12% as operation twist should command. Using a spreadsheet model, you can play around with the prices to find a comfortable yield that will move the price closer to present value. Refer to the chart below for a visual breakdown.

*Check out the brochure to learn more about custom strategies (FX trading for now) in the Research & Advisory Section.