Bonds Price-in Inflation!
Fundamentals
The FOMC decided to increase the purchases of financial assets to $600 billion, eclipsing the consensus estimate of $500 billion. What on the surface could be seen as bullish for the Bond market actually triggered a sell-off in long-dated treasuries. At the same time, T-Note prices moved very little after the Fed's policy statement. This steepening of the yield curve signals that Bond traders are expecting inflation to balloon, due to the Fed's fixation on stimulating growth and combating deflation. The FOMC decision may have more far-reaching effects than Tuesday's mid-term elections, as the potential inflationary threats to the economy may be far too detrimental for Washington to clean up. The Fed is also targeting medium-term securities, favoring Notes over Bonds. The market sentiment is that the central bank is going for the "sugar high" of short-term growth at the expense of long-term expansion. The Bond market has been propped up by the Fed's purchasing of treasuries, but the size of asset purchases could tip the scales in the favor the bear camp and trigger long liquidation. The move makes commodities far more attractive than fixed income products, barring an economic meltdown.
Trading Ideas
The FOMC's decision to increase the purchases of medium-term assets seems to favor Notes over Bonds. Not only is there going to be demand for Notes, but the long-term inflationary effects of the Fed's policy make longer-dated fixed income products far less attractive. For this reason, some traders may wish to explore taking on a bearish strategy in the December Bond contract, such as a bear put spread. Some traders may wish to consider purchasing a December Bond 128 put (USZ0128P) and selling a December 126 put (USZ0126P) for a debit of 0-14, or $281.25. The spread risks the initial premium for a potential profit of $1,718.75 if the December contract closes below 126 at expiration.
Technicals
Turning to the chart, we see the December Bond contract now trading near support at the 130-00 level. A significant close below support could trigger stops and cause longs to liquidate positions. The market has been forming a wedge on the daily chart since August, and 130-00 is also the lower boundary of this pattern. Prices are also resting on the 100-day moving average. A close above this average can perhaps be viewed as bearish over the mid to long-term.
Rob Kurzatkowski, Senior Commodity Analyst
