In a Bond State of Mind
Thursday, July 28, 2011
Even if a compromise (a word seemingly not part of either party's vocabularies) is reached, Bond market fundamentals may remain mixed. This suggests sideways and choppy trading ahead for Bond prices. It is difficult to see prices test 130-00 without a global economic meltdown. Technically, Bonds remain neutral with a slight downward bias, given the inability of the market to breakout above 127-00. Choosing a direction for the market may be difficult, which is why some traders may perhaps opt to enter into a short call position, like, for example, possibly selling the September Bond 129 calls for a credit of 0-36, or $562.50. The maximum profit would be the initial credit and the trade has unlimited risk. To mitigate this risk, some traders may want to consider exiting the short call position on a close above 128-00. Also, some traders may want to consider a gamma hedge by buying several 133 calls at 0-05.
Fundamentals
Bond futures have been trading sideways to lower over the course of this month, largely due to the debt ceiling debate. The fundamental tug-of-war has been a source of confusion for many traders. On one hand, failure to reach an agreement on a debt ceiling plan would likely be seen as a huge negative for treasuries because of the inevitable downgrade to US debt and concern over coupon payments. On the other hand, the trouble in the US has been overshadowed by European debt concerns. The possibility of default and/or missed interest payments is much greater in Europe than in the US, which could be a boost for Bonds. Also, the current state of the economy has been a major concern for many traders, which could be seen as supportive, but may not necessarily drive prices higher. The current higher price of Bonds (and low yields) suggests that there would have to be a genuine panic similar to 2008 for prices to move much higher.
Technical Notes
Turning to the chart, we see the September Bond contract continue to trade in a tight range between 125-00 and 127-00. The 127-00 mark has been a major hurdle for Bonds, with prices failing to break through, despite numerous attempts to break out. Thus, this likely should be considered critical resistance. A breakout below 125-00 suggests that prices could come down to test 122-16. Failure to hold 122-16 would be a major technical setback for the Bond market, as it would signal a double-top and could result in a full-on meltdown in prices. The 20 and 50-day moving averages are now just north of the 125-00 mark, which would make a downside breakout all the more negative.
Rob Kurzatkowski, Senior Commodity Analyst
