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What’s the bond rally all about?

17 November 2008

The Technical Trader’s view:
This market has gone nowhere but up since we argued that Bond markets ( in particular US T Notes) looked vulnerable in our Market Update of October 30th entitled: ‘Whither Bonds? Sell ‘em hard! When?’


In mitigation, we identified a series of levels beneath the US T Note market which had to break before we became bearish.

Needles to say none of them broke!

Instead the market is testing the old highs.

And other bonds markets are doing even better: look at the Bunds.


Bulls are excited that the succession of Prior Highs has been overcome.

Certainly, the market has paused and retraced a little in the last day or so, but those old Highs look good support.

This though, is a little less bullish.

Certainly the market has pushed to the top of the trading range.

But bulls should wait for a clear confirmed break above the 118.48 High on a weekly basis.

If that happens, taken together with the daily chart, the bears will have to capitulate – for quite a while.

A bull move of some eight big figures would be suggested by that bull break.

Wait for the break!

The Macro Trader’s view:
Readers of the Macro Trader’s Guide will know our views on Bonds: we have been long-term bears, but due to the price action in the market we have stood aside, judging sentiment and timing were against us ‘short term’.

We had viewed the relative strength of Bonds over recent weeks as likely, short term, since our focus had been the clear deterioration of the fiscal stance of not only the UK, but also the US and the Euro zone.

Clearly the most negative of these markets is the US 10 year note and UK Gilt, as both governments have been obliged to commit vast amounts of tax payers money, unfunded by tax receipts, to rescues ranging from insurance companies and mortgage giants in the US, to high street Banks and Building societies in the UK.

While the Euro zone too, has committed large sums to recapitalize its Banks, most politicians haven’t been trumpeting the need to spend their way out of the crisis, as has the Brown government in the UK with unbridled alacrity.

This led us to argue in favour of the relative strength of the Euro Bund over recent weeks. But in general terms we have expected bond yields to rise as governments globally are forced to increase Sovereign bond issuance to cover their many and varied interventions.

However, while we haven’t lost money over this stance, (we have remained square), we are struck by not only the resilience of bond markets, but their outright bullishness.
How much longer can this last and, indeed, have we been wrong?

Clearly, traders have been overwhelmingly pre-occupied with the economic weakness of the global economy, and more importantly, the very nature of the current downturn itself.

So why are governments queuing to borrow their way out of this crisis? Ironically, it was over indebtedness of the western populations that led to the crisis in the first place, especially in the UK and US but elsewhere also,.

So too much borrowing got us into this mess, but politicians think that even more borrowing will get us out of it.

They may be right, but it will only work if what is being proposed looks sustainable and appears temporary. If the general fiscal position is to be materially weakened, and that level then becomes the “base line” moving forward, then we judge bond yields will indeed rise as traders and investors judge the situation untenable, but if a credible plan is simultaneously adopted showing a clear and workable path back towards fiscal rectitude, then bond yields may well fall further.

At present it isn’t clear how the global authorities (especially in the UK) intend to manage this. While we are beginning to revise our short and medium-term view about the direction of Bond yields, only evidence that any increase in borrowing will be only temporary would encourage us to go long. And longer term, much depends on the depth of the current recession and the mix of both fiscal and monetary policy moving forward.

Mark Sturdy
John Lewis
Seven Days Ahead

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