Too Flat?
Fundamentals
Bond prices have taken a break the past two sessions, after rallying well into the 130's. Yields have continued to move lower and lower due to surprisingly strong demand for treasuries. One would think that the recent weakness in the US Dollar and unattractive yields would cool buy buying, but that has not been the case. The Fed has indicated that it would step-up its purchases of US debt, amid speculation that economic growth will slow. The central bank has not given traders the faintest idea of when it would begin tightening rates. Many market observers speculate that the Fed could keep rates at extremely low levels for two years. The fact that the stock market has failed to string together several strong sessions in a row has done little to instill investor confidence. Safe haven instruments such as treasuries and Gold have performed extremely well lately, which is a clear sign that investors remain uneasy. Traders are now left guessing how flat the yield curve will get before demand dissipates. Given the sharp rise in prices (drop in yields), some traders may begin to favor other defensive instruments such as Gold over Bonds, to capitalize on the low lease rates. The drop in yields coupled with the decline of the greenback may also make Bonds unappealing for foreign investors. If overseas demand does drop, it will be interesting to see if Fed buying will be able to fill the void created.
Trading Ideas
The Bond market fundamentals remain relatively unclear at the moment. Fed buying could be seen as supportive for the market, but the low yields and weak Dollar could work against Bond prices. Technically, the market can be seen as overstretched in the near-term, which may favor flat to lower trading. Some traders may wish to consider putting on a short-term bearish strategy, such as a bear put spread; e.g., buying the Sep Bond 133 puts (USU0133P) and selling the Sep 131 puts (USU0131P) for a debit of 0-40, or $625. This bear put spread risks the initial premium for a potential profit of 1-24, or $1,375.
Technicals
The Bond chart shows prices reaching levels not seen since the panic buying of late 2008 to early 2009. Prices did run into run into resistance just under the 134-00 level, which is where prices have stalled, at least temporarily. The next areas of resistance would come in around the 135-00 and 137-00 levels. Near-term support can be seen centering around the 130-00 level. The sharp rise in prices has caused the RSI to cross over into overbought territory, which could help cool buying.
Robert Kurzatkowski, Trading Specialist
