Bond Boredom
Fundamentals
Treasury futures have weakened since mid-July on stronger equity and commodity prices. Recent economic reports have reversed course and shown significant improvement, especially in housing, which has weakened demand for defensive instruments. Rising commodity prices once again raise the prospect of inflationary pressure creeping into the economy, lessening the appeal of fixed income instruments. There has also been the question of supply and demand. The increased government spending both by the previous and current administrations has resulted in more frequent and larger Bond issues, much to the ire of existing debt holders. China has noted its displeasure at the size of the US debt on several occasions, leaving US officials scrambling to reassure the emerging nation that government deficits will shrink. It is difficult to reassure investors in government debt when there is so much supply and very little demand, which could cause yields to rise if the equity rally continues. Not everyone is bearish on Bonds, however. Many investors may be seeing this as an opportune time to enter the treasury market, as they are skeptical of a long-term economic recovery. Many have brought up the prospect of a double dip recession, where the economy will recover for a brief period before falling into another recession. This viewpoint does not represent the consensus opinion in the market but, nonetheless, does represent enough investors to avoid a large scale collapse in the Bond market.
Trading Ideas
The mixed technical and fundamental data suggests that Bond traders may wish to capitalize on the range-bound trading range instead of attempting to catch a trend up or down. Further declines in Bond prices could create a short-term buying opportunity for traders. One such trade would be to buy the September Bond contract at 114-00 with a protective stop at 111-25 and an upside target of 118-00. This trade would risk roughly $2,218.75 for a profit potential of $4,000. A more conservative strategy would entail buying a September Bond 116 call (USU9116C) and selling a September Bond 118 call (USU9118C) for a debit of 0-45, or $703.13. The maximum profit on the spread is $1,296.87.
Technicals
Turning to the chart, the September Bond contract was unable to mount rallies beyond mid-May highs and has fallen back to the mid teens as a result. This indicates that the market may be stuck in range-bound trading between 112-00 and 121-00 for the foreseeable future. The 112-00 level is of key importance for the Bond contract, as this has been a significant support level for the past two years. Failure to hold at 112-00 could be seen as a major downside breakout. It does not look like there is enough momentum to push prices below this level at this point, as indicators are giving oversold readings, which would be seen as supportive for the market.
Rob Kurzatkowski, Senior Commodity Analyst
