Traders might be best served carrying a bullish bias in Treasuries in the coming months
It seems the majority of money managers and analysts are blatantly touting their distrust for the Treasury bull, yet a combination of Federal Reserve buying and risk asset pessimism has kept prices at historically lofty levels and, therefore, yields near all-time lows.
We agree that at some point the rug will be pulled from underneath the market, but the odds are against such a move happening within the next several months. Accordingly, we believe Treasury bond and note prices will likely remain overall range-bound; any large dip could be seen as a buying opportunity for short term traders looking for speculative price appreciation in this complex, rather than investment yield.
The relentless stock market rally has encouraged retail investors to reallocate funds into equities and out of Treasuries, but weakness in bonds and notes doesn’t match the strength we’ve seen in the major stock indices. In our view, this points toward an underlying sense of anxiety in the marketplace and creates an atmosphere prone to panicked trade, which typically results in swift and plentiful purchases of safety assets such as U.S. Treasuries. Similarly, continued rotation out of Treasuries and into stocks would likely require continued strength in equity prices and there are signs pointing toward consolidation, or worse, in stock indices.
In addition, in the coming weeks seasonal tendencies will be approaching potential reversal points in both the stock and bond arenas. After all, the month of April marks the end of what the Stock Trader’s Almanac calls “the best six months” for the stock market. Further, according to the Commodity Trader’s Almanac, also written by Jeffrey Hirsch, going long the September 30-year bond futures contract on or about April 24th and exiting the position on or about August 19th, has experienced a success rate of about 70%. Clearly seasonals aren’t due to firm up until mid to late April, but in our opinion there should be a relatively stable base in pricing to enable traders to be somewhat comfortable getting bullish in dips.
When analyzing a market, we always look to the Commodity Futures Trading Commission’s Commitment of Traders Report to see where the various market participant groups are putting their money to work. In the latest C.O.T. report, the CFTC claims that large speculators shifted their overall stance from long to short last week. As a result, the data suggests they came into this week with the largest net short position they’ve owned since August of 2012. In light of the weekend news out of Cyprus and rekindled Euro tension, we now know this was inopportune timing to be heavily short. We suspect that this group will look to cover shorts (buy back contracts) on dips as they reconsider their outlook on interest rates. This should keep a floor under Treasuries, at least for now.
Although we specialize in the futures markets and are not qualified to issue stock advice, we found that the timing of this analysis fell on the expiration of the March futures contract and the new front month, June, hasn’t developed a chart that can be accurately studied in an intermediate time frame. As a result, we’ve opted to take a look at yields in the bench mark 10-year note and the equity product, TLT, for our chart work. We’ll then translate that analysis into futures pricing.
We believe that a quick look at the weekly chart of the TLT, which is the iShares Barclays 20+ Year Treasury Bond ETF, confirms our inclination to be bullish on dips in the Treasury complex for the time being. Specifically, we see immediate support in the TLT near $114.59, but feel any weakness will likely test the long-term up-trend line near $112.40ish. In the futures market, this is equivalent to about 130’02 and 129’08, respectively, in the June 10-year note futures contract.
Ideally, we prefer to see an RSI (Relative Strength Index below 30 before we can be comfortably bullish, but such an environment can be few and far between; however, a move to the $112.40 area in the TLT could be enough to do it. Naturally, when attempting to get bullish at lower levels there is always risk of missing the trade. Accordingly, some traders might look to nibble at current levels.
The Slow Stochastics oscillator, is trolling under 20 to suggest prices are oversold and could be due for a reversal. In our opinion, the market has a substantial chance of breaking out of the current wedge on the upside. For instance, a break of wedge resistance ranging from $120.50 to $121.00 in the TLT, should trigger follow through buying into the mid to low $127.00 area. Although we aren’t counting on a retest of the July 2012 highs near $132.15, which were made in the midst of European panic, we can’t rule it out. Traders are fickle and, unfortunately, have been conditioned to panic by the 2008 financial crisis. Translated into the June 10-year note futures contract these levels are, 132’12, 133’02 and 135’29 respectively.
If you prefer charting the yield, we see a similar trading range; this isn’t surprising because yields and Treasuries move inversely. Converse of Treasury prices, the current up-trend in yields could be capped by seasonal and technical resistance. Trend-line resistance in yield should be found near 2.1% but if this level is penetrated, the gap fill near 2.175 to 2% should act as a ceiling for now. Based on our chart work, it seems a retreat in yields toward 1.7% could be in play with a possible, but not likely, retest of the 1.4% area.
Keep in mind that products such as the TLT or T-Note futures are an index of Treasury securities, rather than a single asset. Accordingly, although they move opposite to yields the exact correlation between price and yield can vary slightly. In other words, it is impossible to assume that a specific change in price in either of these assets will equate to an exact change in yield.
