Good News is Bad News for Bond Bulls

Posted by Futures on January 7, 2011 9:05 AM

The pace of the sell-off in Bond prices has started to slow the past several trading sessions, as prices have moved into a consolidation phase to start 2011. With Bond prices currently near the low end of the recent price range, traders looking for a correction to the bearish trend may wish to investigate the purchase of a bull call spread. For example, with March Bonds trading at 120-05 as of this writing, the March Bond 121 calls could be bought and the March Bond 124 calls sold for about 1-02, or $1,031.25 per spread, not including commissions. The premium paid would be the maximum potential loss on the trade, with a potential profit of $3,000 minus the premium paid realized should March Bonds be trading above 124-00 at option expiration in February.

Positive economic data has not been kind to Bond bulls, as traders have fled their safe haven purchases in Treasuries and have moved into less risk averse trades such as equities and commodities. Since the recent highs were made back in late August of last year, lead month Treasury Bond futures have fallen by nearly 18 full points, as current yields have soared to over 4.50% for the long bond. Recent weakness in Bond prices was triggered by a hugely optimistic estimate on private sector jobs created last month from ADP, which said that 297,000 jobs were created last month. This was well above the gain of 100,000 jobs most traders were expecting and has raised the bar for this morning’s monthly Non-farm Payrolls report. Some analysts are now expecting an increase of over 200,000 jobs, and any short-fall could spark some short-covering buying in Treasuries, as traders’ expectations for employment have risen sharply. The improved economic data has triggered some talk that the Federal Reserve (Fed) will possibly curtail some of its purchases of Treasuries in its latest program of quantitative easing, though a perusal of the recently released Fed minutes shows little indication that the Fed will not fulfill its $600 billion purchase of Treasuries by June.

Looking at the daily continuous chart for the lead month Bond futures, we notice prices finally moving into a consolidation pattern after a sharp 3-month-long decline in prices. Volume has also dropped off during this consolidation, which might be setting the stage for a sharp breakout once volume increases. The 14-day RSI has rallied off oversold readings and currently stands at a more neutral reading of 41.99. The December 15th low of 118-21 is seen as strong support for the March contract, with resistance found at the recent high of 123-00.

Mike Zarembski, Senior Commodity Analyst