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- Donna Heidkamp | |
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Despite the feeling of gloom and doom on the minds of consumers and investors, the economy will eventually improve, and sometime over the next several months the U.S. faces pending inflation. This is keeping U.S. Treasury futures in a sideways trading range with the possibility of a downside breakout on the fear of inflation due to a host of reasons beginning with a surplus of debt in the markets -- or an upside breakout due to the possibility of government intervention to try to keep rates low as long as possible to help the housing market or the possibility of increased debt purchases from sovereign banks. From a longer term perspective, we are keeping a close
eye on the note and bond markets for an opportunity to establish a short position as an inflationary hedge. Overall, inflation is the buzzword in all of the markets, but is particularly equipped to send Treasuries moving in either direction in the short term.
Global Liquidity
Last week's proverbial "shot across the bow" from China's Premier Wen Jiabao on the future direction of the US dollar and the its potential effects on China's massive US treasury holdings is a strong reminder that the markets are still very much concerned with the dual threat of future inflation coupled with a weak dollar.
The Chinese are aware of this and have in the past kept their comments to private meetings with US officials. Any changes in the Chinese government willingness to support US treasuries should be reflected in the US treasury auctions in the coming months. This should introduce a certain level of uneasiness in the price action for the 30-year bond with a breakout occurring only after the market knows which way the Chinese will go.
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The United States has been printing money since 1998. At that time the US Fed and other central banks started pumping liquidity into the global system to stave off any potential negative shocks from the transition to Y2K. Unfortunately, the dot com bubble burst almost immediately after Y2K and the Fed, hoping to stave off a recession, continued providing the world with liquidity.
The Sep 11th attacks in 2001 convinced the Fed that the liquidity tap should be opened further and as a result the Fed lowered the Fed Funds target rate from 3.50 to 1.00 in July of 2003 and kept rates artificially low until it started raising them again a year later. Unfortunately, the damage had been done and the real estate bubble begun as a result of the easy credit provided by Alan Greenspan's Fed.
With the popping of the real estate bubble, and in an effort to avoid a bad recession, the US Fed has lowered rates from 5.25% in Sep 2007 to the present 0.25%.
Historically, the opening of the liquidity spigot if not kept in check can very easily lead to inflation and the devaluation of the currency.
The Chinese are concerned that the United States propensity to try and print its way out of bubbles and recessions will greatly erode the value of US securities.
Debt Supply Absorption Brings on Rally
Going forward, there is good reason to believe that the markets will place more importance on bond auction results. There are expectations the Treasury will issue a huge wave of new debt this year to help fund government rescue plans for the financial industry, and the Treasury auctioned $11 billion long bonds this week, following $119 billion in short-term bills and $52 billion in notes sold. The sale is the first time the government has tried reopening the so-called long bond a month after the initial sale. In a reopening, the debt for sale carries the same coupon and maturity as the original bonds. Reopening 30-year bonds is one of several steps the government has had to take of late
to increase issuance to finance all the stimulus spending, tax breaks, and the Federal Reserve's liquidity initiatives to restart U.S. economic growth and financial markets.
The overriding factor for the bond market has been the overwhelming supply. Better-than-expected reception for the 10-year and 30-year supply has calmed anxiety that investors were reluctant to buy more Treasuries. The market managed to assimilate this week's massive supply influx; overall demand for the reopening of the 30-year issue came in above its long-term average at a yield of 3.640%. The current 30-year bond (UST30Y) recently traded at a 3.69% yield, up 2 basis points. | |
China Deflation Speculation
The weakness in China's economy could also contribute to the downside in the U.S. Treasury futures markets. The d-word -- deflation -- has even been tossed around about China. Data released by the National Bureau of Statistics showed China's inflation fell 1.6% in February from the year-ago month, falling for the first time in more than six years. A 1.9 percent decline in food prices, a major component of the index, and declines in international commodity prices helped to drag the index down. So did excess inventories for many industries. China's government downplayed the likelihood of a deflationary spiral, saying the fall in the CPI was due in part to inflation being very high in
February last year, when the index's rise reached a 12-year high of 8.7 per cent.
But sliding prices of goods could spur consumers to delay purchases in the hope of securing better bargains in future, and could signal the beginning of a period of price deflation.
In the U.S., state sales tax receipts are declining across the nation as well, prompting further state budget cuts or tapping a larger share of the federal stimulus package to balance the budget.
Following is a trade recommendation to try to take advantage of a near term breakout of the consolidated trading pattern. (Learn more about the basic principles professional futures traders live by with
20 Tips to More Successful Futures Trading.) The premium collected on the example is based on prices as of March 13th. If we do not see a breakout in the market come to fruition, we are simply looking to capture a profit due to time decay of the options.
Recommendation:
Sell 1 May US 123 Put
Sell 1 May US 128 Call
Premium collected: 4-32/64 or $4,500.
43 Days to Expiration
From a risk management standpoint, work futures orders to buy June Bonds 128-12.0 stop and work to sell June Bonds at 122-31.5 stop
Based on the chart, we will likely have a breakout one way or another by early- to mid-April. Daily JUN 30-year US Treasury Bonds
If you cannot view the T-Bonds chart, go here.
Source: CQG, Inc.
The risk of trading can be substantial and each investor and/or trader must consider
whether this is a suitable investment. Past performance, whether actual or indicated
by simulated historical tests of strategies, is not indicative of future results.
Futures trading involves risk of loss. Trading advice is based on information
taken from trades and statistical services and other sources which R.J.O'Brien
believes are reliable. We do not assure that such information is accurate or
complete and it should be relied upon as such. Trading advice reflects our good
faith judgment at a specific time and is subject to change without notice. There
is no assurance that the advice we give will result in profitable trades. All
trading decisions will be made by the account holder. Past performance is not
necessarily indicative of future trading results. | |
About the Author
Donna Heidkamp is a Senior Trading Advisor at RJO Futures. Her interest in the futures industry stems from strong family ties to production agriculture in Hereford, Texas. After completing a bachelor's degree in Agricultural Economics at Texas Tech University in 1995, Donna moved to Chicago to participate in the Chicago Mercantile Exchange Agricultural Broker Training Program. The program exposed her to all facets of the futures industry, enabling her to work with experienced floor traders and develop a strong understanding of the intricacies of trading in the futures markets.
Since completing the training program in 1995, Donna has continued to gain a well-rounded knowledge of the industry by working as an order clerk, trading desk manager, and broker for RJO Futures. In 2004, she started a branch office of RJO Futures to focus her efforts on helping clients meet their trading goals. By identifying client objectives, managing risk, and providing a carefully tailored service, Donna serves as a dedicated liaison on all trading floors to full-service, broker assist, and online clients. Donna's commentary can also be heard regularly on CNBC TV and Bloomberg.
In order to continue to better serve her customers in an ever-evolving and dynamic industry, she also completed a M.S. degree in Financial Markets and Trading from the Illinois Institute of Technology in May of 1999.
RJO Futures is the retail division of R.J. O'Brien, one of the oldest FCMs tracing its history back to 1914. | |
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