Cheap at half the yield?
Fundamentals
The long end of the Treasuries yield curve reminds unloved by speculators despite relatively attractive interest rates when compared to shorter maturities. For example, the yield on 2-year treasuries is a scant 0.42%. The 30-year bond however is currently yielding 4.33%. This huge difference is the product of investors' fears of longer term inflation as well as the Federal Reserve's purchases of U.S. Government debt (QE2). The recent Fed announcement that it would be purchasing $600 billion of U.S. Treasuries is to be centered in the 3 to 7 year maturities, not at the long end of the yield curve. A steepening of the yield curve is considered a boon to banks which can currently borrow at close to zero percent short term rates and purchase longer term treasuries and collect the yield difference. Ironically one of the Fed's reasons for treasury purchases was to help keep interest rates lows, especially mortgage rates which are normally tied to rates on longer term treasuries. But by focusing its purchases on much shorter maturities, it is actually further steepening the curve and not helping to keep longer-term interest rates in check. Looking at the most recent Commitment of traders report we notice large speculators are holding a net-short position in 30-year bond futures of just over 25,000 contracts as of November 2nd. In the 10-year note futures, however, these large specs are net-long over 15,000 contracts. This report shows that these large trades still expect the yield curve to widen even further. Though the December bond futures are trading nearly 8-full points off of recent highs, prices are still holding above the 200-day moving average that many traders look at to determine is a market's trend is bullish or bearish. In addition, there was a "hammer" pattern formed in Japanese Candlestick charting earlier this week which is normally considered a bullish reversal pattern that forms after a decline, and can be viewed as major support point for the market.
Trading Ideas
Traders who believe that the recent sell-off in 30-year bond futures was nothing more than a correction in a bull market may wish to investigate bullish trading strategies(such a purchasing a bull call spread) using bond futures options. For example, with March bonds trading at 127-05 as of this writing, one could buy the January 128 calls and sell the January 132 calls for 1-16/64 or $1,250 not including commissions. The premium paid is the maximum potential risk on the trade, with a potential gain of $4,000 minus the premium paid which would be realized if March bonds are trading above 132-00 at option expiration in late December.
Technicals
Looking at the daily continuation chart for 30-year bond futures, we notice the market is still in the midst of a correction since the recent highs were made back in August of this year. Prices are now below the 20-day moving average which favors short term bond bears but still above the 200-day moving average which still confirms the longer term bullish trend. Those trades who follow Japanese Candlestick charting will notice the "Hammer" that formed from Wednesday's trade, which is considered a "reversal" indicator and may be signaling a near-term bottom. The 14-day RSI has turned weak with a current reading of 38.69. Wednesday's lows of 127-14 need to hold or the market may be set for a test of the 200-day moving average currently near the 125-00 area. Resistance is found at the November 3rd highs of 133-00.
Mike Zarembski, Senior Commodity Analyst
