Long Treasury Bond

In posts dated 8/19/10 and 8/24/10, I argued that the long bond was strongly overbought and
that it was overdiscounting a presumably weaker economic environment. I stated that the $USB
which was trading around 135 could lose up to 20 price points in a correction, and warned that
with large pools of fast money such as hedge funds in the market, change could be fast and
dramatic when it came. Well, today the future is trading around 121.8 in a downtrending market.
The market is now oversold, but since major support lies down around 115, one needs to be
careful $USB.

The sharp reversal in the market reflects several factors. Shorter run leading economic
indicators turned positive in late Aug. and, consumer spending has strengthened. The Fed's
commitment to a quantitative easing of monetary policy gives concern to Treasury players
that economic growth potential may be enhanced. Inflation pressurge gauges have started to
rise here in the autumn, and finally, an outline of a "tax deal" between Pres. Obama and
congressional GOP leaders contains modest additional stimulus which would aid the
the economy but boost the budget deficit as well. 

the long Treasury yield has been anchored by a near zero 91-day T bill yield and a volatile
but low inflation rate. Seasoned bond players know that as an economic recovery progresses,
inflation pressures eventually build as does credit demand. The normal response of the Fed
is to cite inflation pressure and raise short term interest rates. There is little risk the Fed will
so respond in the months straight ahead, but a firming economy can bring more inflation
pressure and sour bond players on the bond even so.

The long Treasury has moved into oversold territory on both technical and fundamental
grounds. However, the long bond could easily fall to $115 support  and the yield could
easily rise to 4.85% resistance in an environment of firming production and rising
sensitive materials prices even as the Fed sits on its hands. There is not enough of an
extreme yet in the market level or in sentiment to warrant more than a long side trade
for an interval too short to suit my taste. I would also point out that bond players tend to
close their books for the year by mid-Dec., so liquidity in the market gets very thin.

I would suggest that should the long Treasury yield move up to and through the 4.80%
level, there would be a rather preliminary indication that the 30 year long bull market
in bonds could finally be winding up. Although such a development could trigger a torrent
of bearish commentary on investment sites, best to remember that a number of other
pieces of the puzzle would have to fall into place to legitimize the claim that the bull is
done.

Long Treasury Yield.