Which Way Will US Treasury Bonds Go?

US T-Bonds have been relatively quiet over the past month, overshadowed by the equity market rally. The tug of war between bulls and bears may continue for the foreseeable future. While equity prices have improved significantly, there is an air of caution due to a lack of trust among traders. Traders have seemingly gotten ahead of themselves after a series of relatively positive economic reports, compared to the dismal data over the past year. In a report to investors, bond manager Pimco expects a severe recession to persist through 2009 and, as a result, bond yields to remain extremely low.

The world’s larger bond fund manager also cautioned that the US consumer is in no position to bail out the world economy like it did in past downturns. Recent CPI and PPI reports continue to show extremely low inflationary readings and industrial production data in both the US and Europe suggest that deflationary concerns have not yet subsided. This gives government debt the upper hand versus Gold and precious metals as a “flight to quality” investment instrument. One cannot talk about T-Bond prices without mentioning the Fed’s treasury buying program, which has kept the price of US debt at artificially high levels. The Fed has purchased over $50 billion worth of treasuries since the program began in late March. While the Fed expects to purchase over $300 billion worth of T-Bills, T-Notes and Bonds over the next six months, it is difficult to see the central bank doing much, if anything, beyond that. The government will continue to issue debt at a record pace - a pace that traders may not be able to digest. While the stock market has rallied over the past month, the exchange rate of the greenback has weakened.

Even if the stock market was to turn lower, there is no guarantee that investors will once again seek the relative safety of the dollar. Instead, overseas investors may invest in government debt domestically, which could result in little change in Bond prices in the US. China had initially balked at the idea of buying more US debt when President Obama’s stimulus bill was passed, but eventually Bejing softened its stance after some political maneuvering, at least publicly. China has been on a commodity buying spree of late, even as its economy tries to find a bottom, with the most notable purchases being in copper and other base metals. This could be a sign that Bejing is diversifying away from dollars, and the cost of buying commodities leaves less cash to buy US debt. They have been extremely vocal in their support of an alternative trade currency to the greenback, and the measures they have taken may be a somewhat covert way of accomplishing this without actually issuing a new global trade currency.

Without Chinese investment in the US Bond market, the US government may find it difficult to find new investors with enough cash to fill the vacuum created. The aforementioned factors support the view that Bond prices may continue to move in a very tight range over the coming weeks and months. Trade Idea: With both fundamentals and technicals giving a neutral bias to the market, traders may wish to employ a neutral trading strategy to benefit if the market continues to trade sideways.

Neutral traders may choose to consider entering a short strangle position by selling a June 13l call and selling a June 122 put for a combined premium of 1-16, or $1,250 per spread. This strategy would call for the price of the June Bond to remain between 122 and 131 on the May 22nd expiration date. Since this strategy can be considered risky and leaves the trader unprotected in the event that Bonds break-out, traders may also choose to leg into a condor spread by buying a June 134 call and buying a June 119 put for a combined debit of 0-32, or $500. This would bring the total credit of the spread down to $750, but may also limit the trader to a maximum loss of 3 full points, or $3,000.

Technicals

The June Bond chart shows the market trading range-bound since the beginning of the year, unable to find a direction. The chart does show what appears to be a double top pattern confirmed at the beginning of the month, but traders have failed to react to the chart pattern to this point. Even if the pattern was to confirm, the downside objective measured by the double top could see the market come down to very stout support at 123. Prices continue to trade near the major moving averages, making the averages a somewhat useless tool technically. The oscillators remain neutral, with the momentum indicator hovering near the zero line and the RSI failing to deviate much from the 50 percent level.

Subscribe by RSS Subscribe by Email