Here Comes The Pain In The Bond Market
From Nic Lenoir of ICAP
As discussed earlier this week and last week, Murphy's law is verified in the bond market as we are inching closer to 122-30 in TY futures and the 5Y future is leaning dangerously on the 100-dma, eyeing the 118-30 support below. The market is arguably still long but trimming. All the buying last week post long end supply is getting stopped out for those who did not cash in on a quick buck, and a lot of pre-FOMC positioning is getting pushed out as well. The irony? People are starting to feed the sell-off mentioning next week's supply... just when real money is about to step up and bid the market again! If you have been playing from the short side the past couple weeks you have been right. I tried to play that way mostly with more or less success catching the tops on the pullbacks (or missing them by a few ticks), and even schatz which I thought would hold up broke the 108.80 level.
However the time has come to look for support and try to cautiously think of getting long again as we reach 122-30 & 119-30 in 10Y and 5Y futures respectively. Yields have backed up quite a bit and with a few more stops to run I think bonds will be compelling enough for real money. Imagine the fun we could have early next week with 3 days of supply (and buy-back!) just ahead of the long weekend. It will probably mark the turning point. For the Bund I see 126.50 corresponding to 122-30 which is a big trend support. It is likely in terms of price action that we get a short-lived bounce toward 128 before the last flush down to that level.
Equity markets are pretty strong today reversing the recent positive correlation between bonds and stocks. For the S&P future I see 1,204/1,213 as the area where you are supposed to fade the bounce. If that resistance zone is bypassed you are supposed to play the melt up again. However if my observations on Fixed Income are right, I doubt we can see more pain there and a final flush alongside strength in equities as these type of moves tend to end up a bit disorderly which in turn has a tendancy to spoil risk appetite.
The Knight Research report that came out yesterday got a lot of press, and I must say I am quite pleased it did since it echoes all the themes I have been pushing since 2008. In terms of fundamentals the big picture is simple: the mercantilist/credit-driven global economy has reached the point of no return. US consumers (or Western consumers for that matter) can no longer borrow their lifestyle. A weaker USD means more expensive comodities with jobs and money still flowing outside of the country, and this dynamic is no longer sustainable. That is why I have called for currency wars early on, that's why we will get import taxes, and I hope it stops there. It is not a rosy picture but again the mechanics are so simple and so obviously broken that it is hard to look at things any other way. It doesn't mean financial markets and consumers will not chose to ignore it for a little while longer, but the end game is clearly in sight as Knight put it. Every day that markets rally based on China no longer hiking or Ireland being bailed out makes me feel like I am trapped in a living dead nightmare. I was hoping to wake up before GM would be allowed to crawl out of its grave, but at this pace I feel we might need to have a Bank of America buy Fannie May and Freddie Mac for every one to wake up in sweat!
Good luck trading,