The Fed's "Tweaks" Keep the Bond Market Rally Alive
Fundamentals
A tweak here and there is music to the ears of bond futures bulls, as the lead month September 30-yr bond futures prices continue to climb, aided by the Federal Reserve's announcement that it would purchase longer-term U.S. Treasuries. The announcement of the purchase came in the statement released after the one-day FOMC meeting concluded on Tuesday. Here the Fed did acknowledge that the economic recovery in the U.S. was losing some momentum, with the jobless rate remaining stubbornly high, despite improving corporate earnings. To help keep interest rates low, especially mortgage rates, the Fed announced that it would reinvest the proceeds from maturing mortgage backed securities into longer-term treasuries. Bond traders initially reacted to this announcement by buying bond futures, which sent the September futures up over a full point to price levels not seen since March of 2009, during the height of the recession. However, prices retreated after traders noted that the Fed would only be purchasing maturities up to 10-years, and not in the longer end of the yield curve. Even so, it now appears that the Fed is serious about doing everything it takes to avoid "Japanese style" deflation in the U.S., and traders are realizing that any increase in interest rates by the Fed could be a long way off, with some analysts now not expecting the first Fed rate hike to occur until the fall of 2011!
Trading Ideas
Traders looking for bond futures to keep the rally going may wish to explore an option selling strategy using puts on bond futures. Technical traders will note strong support on the daily chart for December bond futures at the 125-00 area, so some bullish traders may wish to explore the sale of a bond put with a strike price below this chart support area. For example, a trader could consider selling an October Bond 124 put. With the December futures trading at 128-17 as of this writing, the 124 put could be sold for 30/64ths, or $468.75 per option, not including commissions. The premium received would be the maximum potential profit on the trade and would be realized if December bonds are trading above 124-00 at option expiration in September. Given the risk involved in selling naked options, traders should have a risk management procedure in place should the trade move against them. An example of such a strategy would be to buy back the short option before expiration should the December bond futures close below support at 125-00.
Technicals
Looking at the daily continuation chart for September 30-yr bonds, we notice the market running to new highs for the move, but closing well off the day's highs. This could be a sign that a potential price correction might be near. Also notice that the 14-day RSI failed to make a new high reading during the recent bullish run. Although near-term support is seen near the uptrend line around the 127-16 area, major support is seen closer to the July lows of 125-07. Resistance is found at Tuesday's highs of 130-23.
Mike Zarembski, Senior Commodity Analyst
