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August 27th, 2010
Sometimes news that is bad, but not as bad as expected is interpreted and being "good news" and that is exactly what happened with today's GDP report. A few months ago, the markets would have cringed at a growth rate of 1.6% but with expectations for the figure to be 1.4% or much less, it was a breath of fresh air. Also a bit bearish for bonds was a slightly hotter than expected GDP deflator.
As always, Ben Bernanke testimony stole some of the thunder from economic news. However, after all was said and done the market reaction to each event seemed to coincide. The Fed chair pricked the bond bubble by stating that they believe the risks of deflation are not significant at this time and by refraining from announcing further quantitative easing. He also pledged to continue to take action should the economic recovery continue to falter.
The markets took his statements as a sign of stability and acted accordingly. However, one day does not make a trend and Monday could be a little more reliable as an indicator of future market direction. After all, option expiration in Treasuries was today and it is our guess that there were a lot of short call traders that bought future earlier in the week to protect positions were scrambling to sell the same futures in an attempt to avoid the inevitable chop that such a strategy poses.
Reminder from yesterday's newsletter:
The 10-year note has found comfort in the 2.5% range, but we doubt this will hold in the long-term. The only other time yields have been this low (late 2008 on similarly low volume trading), the move quickly proved to be a temporary anomaly. That said, if you recall the last sub-2.5 trade yields reached 2% in dramatic fashion before reversing course. Therefore, what seem to be favorable historical odds...there is a substantial amount of risk involved in speculating the so-called Treasury bubble.
If you missed this trade yesterday:
Clients were advised to purchase October 5-year note 120 calls and sell futures this afternoon for a total risk of under $600 (before considering transaction costs). This gives traders 30 days in the market with unlimited profit potential, capped risk and the ability to quickly adjust or take profits (futures face much tighter spreads than options).
A good exit point in the futures might be just under 119 and depending on how things look, it might be worthwhile to hold on to the long call in hopes of a rebound. Stay tuned...
You should be trading December futures by now...We think the near-term highs are in, but let's face it there is no such thing as easy money. As noted in yesterday's newsletter support in the December 10-year note lies at 124'04ish. This marks the up-trend line as well as other technical areas (Fibonacci and MA analysis). Friday's plunge tested the 124'07 area and puts the market at a significant make or break point. There might be some buyers trying to come in at this level, but failure here could lead to a slide to the mid-122's...at which point we would have to be bullish based on seasonal factors.
In the meantime, the 30-year bond futures look to be much more vulnerable. The first "good" support in bonds doesn't come in until we see 131, but 4 handles off the weekly highs leaves the selling a bit overheated and we could see a Monday morning bounce.
