An Opening For US Bond Bulls?

by .
Alistair Meadows
Alistair Meadows

A year into the Federal Reserves’ interest rate rising process, bonds have seen big declines, as they adjust to the new normal of 4% interest rates worldwide. As the next chart shows however, leverage traders (i.e. Hedge funds) are now massively short, almost at levels pertaining in July 2019.

After that level of bearishness was reached, US Treasuries saw yields fall from 1.5% down to below 1%, in the process marking the peak of global bond markets.

Rate Cycle

Should markets start to perceive that the end of the rate hiking cycle is close, prices could move up substantially, as there are a lot of shorts needing to cover.

Luckily for potential buyers, on Friday (Feb 3rd), the US jobs number was very strong, allowing prices to fall and providing a decent entry point for bulls.

The problem with it is that much of the gains were as a result of seasonal adjustments to past data. At the same time as NON Farm Payrolls jobs growth was booming, other indicators were saying the opposite and the absolute level of full time employment was at the same level as May 2022….

10 Yr COT Feb 2023

The price chart does suggest slightly lower prices could be ahead, but it is not clear how much more bearish bond traders can get.

The near month Treasury options market contract expires on February 24th and has a large amount of open interest starting from the 110.5 strike price up to 114. This should provide a great deal of support for any declines, at least until then.

10 Yr T-Note Feb 2023

Risk Management

As usual, the difficulty is in stop placement.

The lower trendline as around 112.5 at present, which might be too far away for comfort; an alternative strategy might be to buy a calendar spread on the futures- sell the March contract (114.07 as of Feb 6th morning) and buy the June contract (around 114.18 ).

The March contract expires in late March (22/3/23), allowing some time for the market to churn for a while before a new up-trend emerges, while at the same time keeping risks relatively low.

Looking at the up side, the last peak came in at 116.08 on 19/1/23. At the very least, a re-test of that area is likely, but if the inflation data continues to come in below expectations, much higher prices are on the cards.