Monday, September 7, 2009

Rates Strategy: Indecision

Last week, I suggested to stick with a long duration view despite the upcoming supply in the US which might warrant some price concessions (Rates Strategy: Still long despite upcoming supply).
In the mean time, 10y USTs have tested their 3.31% mid-July lows, however, on a closing basis failed to overcome this level. As the chart below shows in yield terms, 10y UST have taken out their upward trend which guided trading in the first half of this year. However, in order to become more bullish, the 3.31% level stands in the way and offers a major support.
10y UST yields
Source: Bloomberg

On the other side, the adjusted 10y TNote future was able to overcome the mid July highs, however, it is still trading far below its downward trendline which started late last year.
Adjusted 10y TNote future
Source: Bloomberg

In the Eurozone, 10y Bund yields - in contrast to their US counterparts - have traded below their mid-July lows but are still guided by the slow upward trend which started earlier this year.
10y Bund yields
Source: Bloomberg

Finally, the adjusted Bund future is the only one which was able to take out the mid July highs and to break through its downward trend.
Adjusted 10y Bund future
Source: Bloomberg
So overall, the technical picture is somehwat mixed at present with cash-yields and futures price charts giving a different picture. Technically, I tend to lean towards a slightly bullish interpretation (given the developments in the Bund future) but admit that effectively we are in a bit of a no man's land with decision time coming closer.

Furthermore, the diverging performance between equities on the one side (up) and commodities and government bonde yields on the other (sideways to lower) continues as the chart below shows.
Equities vs. 10y Bunds and commodities
Source: Bloomberg

Ceteris paribus, lower commodity prices means lower inflation (which is good for bonds) but constitute a positive terms of trade shock for net-commodity importing countries (which is good for corporates and households as it raises their purchasing power and therefore it is good for equities). In turn, the inflation outlook remains supportive for bonds even though the ongoing rally in equities - amid improving expectations for real growth - constitute a significant headwind. The combination - lower inflation pressures and higher real growth - suggest that expectations for nominal growth remain more or less unchanged which confirms the indecision in the technical picture.
In turn, the near term fundamental developments as well as the technical picture are not sending a clear bullish or bearish signal for government bonds and near-term performance is likely to be muted/guided by the upcoming supply. So overall, this does not send strong signals yet to change my view and I stick with my tactical long duration stance for the time being.

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