22nd December Bond Futures Overview
22nd December 2009
Bond Futures
Overview
Over the last five days we have seen the Bond futures continue to trade in a sideways range. The Bund future briefly spiked through the supporting range last week, only to turn around and retest around its recent high prints. T-Notes have resumed their steady downtrend during the same period, having briefly tested around the 118.000 handle.
Thoughts from the trading floor
The last week has seen the Bund future trade in a volatile sideways range. After breaking down to the 122.10 level, shaking out weak longs on the break of 122.34, the market made a firm comeback to make highs around 123.66. This choppy price action has continued to prevail over this week, and we have seen another test of the 122.34 level in early trade today. 10yr USTs have largely channelled lower over the last week. Having followed Bunds higher last week, to make highs around the 118.000 handle, the market sold off sharply, and is currently trading around the important 116.110-200 area. Technically, this should mark the extreme lows of a short-term market correction, and thus a firm break below here may result in extended weakness to the 115.000 handle. There is a sizable gap between the expired Dec’09 and Mar ’10 T-Note futures contract. The Dec’09 expired around the 118.000 handle. The previous time we saw this phenomenon was at the Sep’09 contract expiry. On that particular occasion, the gap was filled within 7 trading days.
We have continued to see a disconnect between the Bund and the T-Note in the last week. USTs have entered a good short-term corrective trend and look weak in the immediate term, whereas the Bund seems to be well supported by the 122.34 level. Other than the previously discussed fundamental factors, there has also been a pick-up in expectation of a strong economic recovery in the US. This has been reflected by the continued strengthening in the USD, which has not been related to safe-haven flows. Should the US economy strengthen quickly next year, the Fed may be forced to move early on rate tightening. This belief may be the main driver of the sell-off seen in USTs in the last week. Although the fact that the UST yield curve has steepened as opposed to flattened would suggest that markets believe that the Fed may be powerless thereafter to prevent high inflation expectations thereafter. We believe that this view may be egregious as it stands. With no real data to suggest this scenario to be likely, the market may have gotten a bit ahead of itself. If markets believe short-term rates will be higher in the near term, as reflected by a higher USD, then the yield curve should be flatter not steeper. If markets believe that the Fed will not prevent rampant inflation expectations, then the USD should be weaker not stronger. The only factor that can explain this egregious pricing could be that the market may be front-running the Fed if they are looking to unwind their balance sheet.
Bull View
Bulls will hope that the recent jitters in the markets persist into next year. With the USD recovering a good part of its losses seen during the early parts of this quarter, the prospect of a broad based sell-off in risk trades early next year should be supportive of the bond market. They will see this correction in USTs as a good buying opportunity. Also, last quarter we saw the large ‘gap’ in the T-note futures filled within 7 trading days. With this in mind, long positions made tomorrow with a stop below today’s lows may present a good risk/reward opportunity.
Bear View
Bears will hope that USTs continue on their short-term corrective trend to the 115.000 handle. They will cite a pick-up in recent macro-economic data (mainly the US Employment situation number) as a reason for the FOMC to gradually withdraw stimulus from the markets, helping USTs lower.
Futex View
We continue to back the Bulls. The recent correction in USTs may prove to shake out weak longs before the market resumes its medium term up-trend. The fiscal positions of many governments globally have the potential to develop into a full-blown crisis early next year and thus Bunds and USTs should provide a natural safe haven (on the proviso that the reserve status of the USD and USTs outweigh fears over the US’s own large fiscal deficit).
