Sep. 4, 2013
There are numerous reasons to be bearish on the Treasury market over the longer time frames. Issuance remains high, the Fed appears poised to taper and eventually wind down its asset purchases, valuations (real and nominal yields) are still relatively unattractive, and at some point the creditworthiness of the Federal government will become strained, to say the least. I could go on and on about the unsustainable debt burden, the many trillions of dollars of unfunded and contingent liabilities, the dangerous, costly, and growing issue of moral hazard, and the rapidly declining ratio of taxpayers to recipients, beneficiaries, and dependents due to shifting demographic trends and political pandering. But I’m operating on a much shorter time frame so I need to focus on the near term variables right now.
One of those variables is investor positioning, and many of the proxies I follow show broad-based shorts in the market. COT data shows that speculators are very short Treasury futures up and down the curve, while real money investors (per Stone & McCarthy and JPM investor surveys) are pretty significantly underweight their benchmark durations. Sentiment surveys, meanwhile, continue to show very bearish readings as well, so my inner contrarian is getting pretty worked up here.
We have some significant events looming in the days and weeks ahead, starting with Friday’s payroll report which will set the tone heading into the September FOMC meeting. A strong payroll report will be widely interpreted as locking in a September taper while a disappointing report will likely buy the market some more time. I certainly don’t claim any insight into the outcome of the employment report but I do feel like the setup offers a decent trading opportunity. That is, I wouldn’t be surprised to see the market test 3% on 10s, which I think would offer traders a nice asymmetric payout profile on Friday morning’s coin toss.
With sentiment and positioning as bearish as it currently is, I think the market has greater potential to rally on a weak number than it does to sell off on a strong one. Call it a half point of additional downside on TY vs a point or more of upside on a big surprise. Again, I really have no idea which way the number goes, but when the odds are 50/50 and the payout is asymmetric, I’ll always get involved.
Meanwhile, I see decent chart support in the 3% area as well. In addition to the psychological value of a 3% 10yr, the level also represents the 61.8% retracement of the entire post-QE rally from the 4% double top in 2009 and 2010 to last summer’s 1.38% low. The top of the trendline connecting the 2010 and 2011 highs currently rests at 3%, and there’s also some trend resistance at 3% on the daily chart in what is starting to look a bit like a rising wedge – typically a termination pattern.
So I like buying 3% tens and if we do happen get a decent post-payrolls / post-fed / quarter-end and year-end short-covering rally we might just make it all the way back to that old 2.40% breakout zone before the year is out. At which point I will be sure to re-acquaint myself with my deeply held, long term disdain for Treasuries.
Happy Trading!
