Make or Break Time for Bonds
Fundamentals
Bond futures continue to drop, causing the yield curve to be at its steepest level since 1980. Improvements to the employment outlook have stoked fears of inflation in the future, which may result in the Fed aggressively raising rates in the future. Also, the size of longer-dated auctions has resulted in lackluster buying interest and an upswing in long bond yields. Supply will likely be a key consideration among traders and will likely inhibit price appreciation unless economic conditions in the US deteriorate quickly. The recent stability the US Dollar has seen may limit the slide in Bond prices. Also, the possible downgrade of British debt could cause international traders to find solace in the relative safety of US debt. The fundamental outlook for Bonds shows grey clouds with silver linings. Today's FOMC policy statement is expected to be very vanilla, so as not to disrupt the markets. Nonetheless, early trading may be somewhat subdued, but volatility could be on the upswing in the afternoon.
Trading Ideas
Given the weak market fundamentals and somewhat shaky technicals, some traders may possibly wish to be short the Bond market. However, there are several factors traders should consider before entering into a position. First, the Fed is expected to keep interest rates low well into next year -- and possibly beyond -- which may prevent yields from jumping much higher, thus limiting the downside potential. Also, a downgrade to UK debt could send shockwaves through the fixed income market and spark flight to quality buying of US Bonds. Lastly, some traders may wish to wait for a solid close below the 117-10 level before a technical breakout is confirmed. Some traders wishing to short the Bond market may want to consider selling the March futures contract on a solid close below 117-10, with a stop at 118-10 and a downside objective of 115-00. The trade risks roughly $1,000 for a potential profit of roughly $2,312.50.
Technicals
Turning to the chart, the March Bond contract has seen very narrow ranges in the past few sessions. Prices have been hovering around the 117-16 level, which can be seen as solid support. If this support level is broken, Bond prices could trade into the lower teens. Failure to violate this support area could result in sideways trading for the foreseeable future between 117 and 120. The RSI remains in the lower end of neutral readings, and a dip to oversold levels can be seen as supportive in the near-term. Momentum is showing some bearish divergence from the RSI, hinting at near-term weakness.
Rob Kurzatkowski, Senior Commodity Analyst
