14th October - Shall we sell Bonds now?
14 October 2013
TECHNICALS:
WEEKLY CHART
The market’s double failure at the 3050 High is very troubling for the bulls.
Note the support at the 50% pull-back which has already forced a substantial bounce once before…
But there is no clear Top formation in place here…
DAILY CHART
The day chart has a near Double failure (not apparent on the weekly chart) at the 3000 level.
Note too the completion of a bear head and Shoulders at the 2760 level (though there was some uncertainty at the Neckline).
Minimum move for the bears measured from the Neckline?
About the Prior Low at 2591.
The bears are in charge.
FUNDAMENTALS:
The US Federal government shut down has had a dramatic impact on markets. What had been a solid year long rally in stocks was brought to a swift end, similarly the sell off in Bonds that was developing into a clear bear market was also brought to a halt.
With US policy makers unable to find common ground over the Federal budget and agree a new debt ceiling, the Government of the United States was forced to lay off thousands of employees to preserve what funds it had remaining.
Clearly with so many workers sent home on un paid furlough there will be an impact on growth as other employers that rely on government contracts have been forced to take similar measures with their employees.
But as if this isn’t bad enough, worse could soon follow. Unless Congress and the President can agree a formulae that creates a climate conducive to negotiating and raises the debt ceiling, if only for a limited time; say 6 – 8 weeks, the US Federal government will be in default.
While we still believe a default will ultimately be avoided, the clock is ticking down and markets and traders are becoming increasingly uneasy about the prospect of the richest country on earth, with the largest economy and reserve currency defaulting on its obligations.
Were that to happen the US would surely fall into recession as would the global economy. The leaders of China and Japan are naturally uneasy, as they hold trillions of Dollars of US Debt and are urging the US to get its house in order.
The impact on bonds has not only been an end to the bear run, but a strong corrective rally has set in, as traders turn away from risk such as equities and paradoxically buy bonds.
But what happens if the US does default?
Clearly there would be a sell off in US Treasuries, but would the US quite literally walk away from those obligations, or would it honour its debts once the budget wrangle and debt ceiling issue was settled?
We believe the US would honour all her debts once the debt ceiling was eventually raised and Bonds, including Treasuries would recover, but at what cost longer term to the US?
The US despite running a massive budget deficit, with a huge debt burden is able to borrow at very favourable rates because she is trusted, default, whether termed as actual or technical would break that trust and the cost of borrowing for the US would be higher than it would otherwise have been.
What then is the outlook for bond markets?
Currently they are a short term if very risky buy. But when this crisis is resolved, as we think it will be, market attention will revert to the core issues which are the Fed’s policy stance on tapering, the health of the economy and strength of corporate earnings.
The impact on markets will be a resumption of the Bull trend in stocks and a return to bearish price action in bonds. So should we sell bonds now? We think not; wait for this crisis to resolve first.
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