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Is that the top for bonds?

08 May 2009

The Technical Trader’s view:

There’s no doubt that the hesitancy at the 124.95 Prior High is a teasing possibility. What needs to happen to really get the bears going? A break of the 116.08 level surely…

Will that happen?

It’s tempting to think so…

The break of the 119.45 prior low has now created good resistance there. The break of the long diagonal from the low in October 2008. Volume’s hot … and then, looking at the wider context, a break of the 115 level would complete a mediumterm Double Top.

The Macro Trader’s view:

Readers of the Macro Traders Guide will be well aware of our long-term bearish view of bonds, especially the Gilt. Our position has rested on the fact that the UK, and other governments from the developed economies have greatly expanded their budget deficits and national debt in an attempt to save
the western banking system and prevent a deep and damaging depression.
This, together with record low interest rates and the adoption of quantum easing policies, has pumped an unprecedented stimulus, both monetary and fiscal into the global and UK economies.

The borrowing requirement that has resulted has given the UK the worst budget deficit ratios in peace time ever and seen: debt to GDP ratios have almost doubled. The consequence of this has been the need to issue £200.B in gilts this year alone.

But the UK isn’t the only major economy issuing unprecedented levels of sovereign debt.

The Euro zone and especially the US have found it necessary to increase public spending and borrowing at a time when traditional buyers/investors of public debt are seeing their own revenue flows decrease due to much lower oil prices in the case of the Middle East oil producers and in the case of China, a chill running through their own economies. So, not only do we expect the glut of new issuance to force bond yields higher, but as recovery begins to appear, no matter how fragile, equity markets will rally, as they have been for several weeks already.

The fear that has lurked in the back of bond traders and investors minds has been that when recovery does take hold, Central Banks will have to time their withdrawal of the monetary stimulus very carefully to avoid an outbreak of inflation.

This will naturally see interest rates rise and long term yields will begin to firm in anticipation of not only the tightening of short term interest rates that will surely occur, but on fears of higher inflation which could, if not controlled, devalue the worth of the bonds governments are current issuing. The tricky calculation of Central Bankers and governments is not to remove the stimulus too soon as recovery needs to be self sustaining. But by the time that is evident, inflation may have already have taken root, requiring higher interest rates and risking another recession.

In short, we judge that as equities rally on accumulating evidence of recovery, bonds will sell off and ultimately they have a long way to fall.

Whether recent price action represents the beginning of the anticipated bear market, only time will tell, but that bear market is coming.

Mark Sturdy,
John Lewis
Seven Days Ahead

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