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Have the TNote and Eurodollars topped out ?

27 February 2009

The Technical Trader’s view:

The drama of the TNote lies in the smashing of the prior High from 2003 which was first
surpassed in November. Since then the market has pulled back three times to test that support. The jury’s out as to whether the market can get back down through it. The bulls are hoping that there is a bull falling wedge. For that to complete wait for a break up through the upper falling diagonal above the market at 122-00 or so. Bears on the other hand will want a breakdown through the recent low at 119-06.We are close that level. It seems to us that a break in good volume would confirm the fall back through the long term support from 2003 which is an additionally bearish signal…

The short end of the curve illustrates similar bear potential as the longer end and, so far, equal uncertainty.The market is teetering on the brink of completing a neat Head and Shoulders Top. We need a convincing close beneath the neckline at 98.27 or so. If that should happen the support from the prior highs at 98.13 and 98.045 like unlikely to provide much to stop the bear move. The minimum target on completion of the H&S Top? 97.70.
But it hasn’t broken yet….

The Macro Trader’s view:

Despite weakening US data, Eurodollars have failed to make any attempt to threaten the highs made in the early part of January. The US 10 year note too, increasingly looks like a market that has run out of bullish impetus.
What lies behind the current price action? Have these markets topped out, signaling the beginnings of a bear market, or are we witnessing a correction?

In the case of Eurodollars, we judge it too soon to begin thinking of a new bear market. True official interest rates have all but hit zero and can go no lower, but the futures market never traded in line with official rates during the current easing cycle. There has always been a lag caused by unusually high LIBOR spreads. And since Eurodollar futures ultimately settle at the 3 month LIBOR rate on the day of expiry, the Eurodollar curve over the last several months has been more a comment on expectations of how LIBOR spreads will evolve as much as official interest rate policy.

Moreover economic data remains extremely weak with both existing and new home sales released this week hitting new all time lows and Durable goods data released today contracting by 5.2%. In addition, jobless claims also announced today, came in at 667k, a level that signals further sharp increases in the unemployment rate. So do we don’t think a new bear market is creating its foundations in the Eurodollar market. Short-term rates can only go up from here, but not yet.

What then of the 10 Year note? This market is significantly off its December 2008 highs, and despite an attempted rally recently, which failed during a period of volatile price action, this market could be setting its self up for a bear move.

True economic weakness as described above, would usually give this market massive bull impetus, but these are not usual times. Not only is the global economy in recession, but governments are throwing vast amounts of money at their economies in the hope they can stave off recession and restart growth. In the US the much-heralded Obama stimulus was initially awaited with great optimism, but last week, as the deal became law, the markets were not so impressed with the final product. However, as more detail has emerged from the US government about how the Bank support package will work, equity markets have staged a limited rally and Bonds have sold off. This reaction has been caused by Obama’s 1st budget; he has announced a deficit of $1.75T, which has pleased equity traders, but has frightened the wits out of bond traders. These are truly very large numbers, and will test the markets appetite to bursting point as the US and other deficit countries, try to fund these spending plans.

We judge markets will demand higher yields and the US Treasury market could be in for a torrid time over the coming months as a new equilibrium is reached that allows the Government the level of funding it needs, but pays investors the risk premium they will demand, not just for the risk of default, but that inflation may not be contained when the economy does recover.

Mark Sturdy,John Lewis
Seven Days Ahead

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