TLT vs. Oil vs. Junk Bonds

What is the "dominant trade"?

Long term treasuries seem to be negatively correlated to oil. You can see it in the chart below. The price of oil is in black and the price of TLT (long term treasury ETF) is in red.

Why am I showing you this?

If the conflict in the Middle East escalates, then the price of oil will spike. And using TLT, or long term treasuries as a recession hedge might not work until the above correlation breaks.

But here is another comparison. Between TLT and “Junk Bonds”. This time TLT is in black and JNK in red.

You see, shorting TLT has a “negative carry”. This means that you have to pay the interest on the bonds that you short. Hedge funds that short TLT, or treasuries, buy another asset that pays a higher interest rate to create a positive carry.

For example, they can buy JNK and short TLT. As you can see in the chart above, this trade has worked great so far.

But if TLT finds a bottom and begins to trend higher, these carry trades would begin to unwind. This means selling JNK and buying TLT to cover the shorts. In other words, if TLT spikes, JNK tanks.

Dominant Trade

What is a dominant trade?