Bonds and Helicopter Money
Fundamentals
Many Bond traders seem to believe that the Fed will step-up its purchases of Bonds and other assets. The central bank has zero wiggle room with regard to actual interest rate policy, leaving the asset purchase program as one of the only means of injecting liquidity. As a result of these expectations and the fact that not everyone is sold on the sustainability of the current market rally, Bonds have been especially resilient. Given the fact that commodities have rallied so strongly in recent weeks, one would expect the Bond market to give back gains in large chunks. This has not been the case due in large part to the Fed’s aggressive actions. Also, because traders are concerned that the stock market may not be able to sustain its strength, the sharp upward movement in commodity prices has been greeted with some skepticism. Deflation has taken the place of the inflation boogie man, as the FOMC believes deflationary pressures could be much more harmful to economic growth than inflation. The central bank believes that it is cheaper to head-off deflation with helicopter money than fight the battle after deflationary pressure seeps in. Barring a marked improvement in economic conditions, the aforementioned factors could keep Bond prices high and rates low.
Trading Ideas
The Fed’s actions have and may continue to support Bond prices. The bank has created an artificially inflated market, but it may be foolhardy to attempt to pick the top in this market. Technically, the market is flirting with a technically critical level that traders need to be mindful off. Given the fact that the central bank in not likely to change their policy of quantitative easing and may actually become more aggressive, some traders may wish to put on a neutral/bullish strategy, such as a bull put spread. An example of this strategy would be selling the December Bond 129 puts (USZ0129P) and buying the December 127 puts (USZ0127P), for a credit of 0-32, or $500. The maximum loss on this trade would be $2,000, but some traders may wish to cut losses by exiting the trade after three consecutive closes below 130.
Technicals
Turning to the chart, we see the December Bond chart coming back toward support near the 130-00 level. The 130-00 mark can be seen as critical for the Bond market, as a breakdown below this level would confirm a double-top on the daily chart. If confirmed, a double-top could result in prices drifting into the mid to low 120’s. The recent wave of selling pressure has resulted in the RSI bordering on oversold levels, which could be supportive in the near-term. Momentum is showing bullish divergence from both price and RSI, suggesting the market may find near-term strength.
Rob Kurzatkowski, Senior Commodity Analyst
