Bonds Rally in the Face of S&P Revision
Today's Idea
Bond market fundamentals remain bearish. The greenback remains relatively weak and the government cannot seem to reign in debt. However, the European debt situation could help avoid a complete market meltdown. Technically, the market is running into resistance, and it is difficult to see prices with enough momentum to cross through the 122-16 level. For this reason, some traders may look to sell a June Bond 124 call for a premium of 0-30, or $468.75. The maximum profit would be the initial credit and the trade has unlimited risk potential. To mitigate risk, some traders may want to close the trade if the underlying futures contract closes above 124-00.
Fundamentals
Bond futures were stronger yesterday, despite the negative economic outlook from Standard & Poor's. Many view this as the initial warning shot and an indication that the ratings firm could strip the US of its AAA credit rating. A downgrade to its debt rating could mean higher borrowing costs, thus lower Bond prices. The showdown in Congress over the federal budget has done little to offer investors encouragement. Both the Fed and Treasury Department have done everything in their power to encourage lawmakers to deal with higher debt, which would result in higher debt supply and could result in a quicker downgrade of government debt. The lone bright spot for the Bond market comes from across the Atlantic in the form of EU bonds. It looks as though Greece and Portugal could both be on the verge of default, and Spanish debt is paying very high yields, which is a sign that a bailout may be needed sooner rather than later. Given the lower default risk in the US, T-Bonds look relatively attractive when compared to their European counterparts. Overall, Bond market fundamentals remain shaky. The move to revise the growth outlook can be seen as a move by S&P to warn investors about a downgrade in order to avoid the panic of a downgrade coming out of left field.
Technical Notes
Turning to the chart, we see the June Bond contract coming up toward a test of resistance near the 122-00 level. If the contract breaks through this level, prices could test 122-16 on the upside. Failure to break through resistance would suggest prices may settle back to their previous trading range. The RSI indicator is approaching overbought levels, which could put some downside pressure on the market.
Rob Kurzatkowski, Senior Commodity Analyst
