Potential Treasury Yield Breakout to Lower Trading Range

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I receive a lot of information from many people as I do this each day. One of the most useful items is a daily morning market analysis from Greenwich Capital. It is a good summary of overnight events and the events which he market will wade through each day.

The author this morning spent some time discussing the possibility that Treasury bond yields will breakout to a new lower trading range prior to the labor data Friday morning.

He lists three solid reasons on why yields could move sharply lower. First, various duration surveys highlight the fact that real investors are flat to short. As yields work lower this class of clients is apt to buy to get flat/long.

European investors are short US versus bonds. As the dollar appreciates that trade becomes painful and if holders choose to exit it will be a source of buying.

Finally, many active traders like to play the ranges. As the ranges are violated those who shorted what they thought were the low end of the trading range are forced to cover. The author noted that 2.98 is resistance on the 5 year note. In my opinion a breach of that level and sustained trading through that level will also bring forth buying.

Update: I wrote earlier this morning about technical factors which could lead to significantly lower bond yields. A salesmen friend and also friend of the blog pointed out to me that the so called skew in the options market would also lead to the same conclusion.

Players in the swaptions market (options on swaps) have for quite some time hedged themselves against higher rates rather than lower rates. Out of the money payers are considerably richer than way out of the money receivers which suggests that clients have hedged against higher rates but not against the possibility of significantly lower rates.

Mortgage clients have held the opinion that the Fed will be on hold for a long time and the next move from that the FOMC is higher rates. I personally think the FOMC will lower rates before it ever raises rates and the swaption market indicates that will bring with it a very painful scramble for duration.

The trades which hurts the greatest number of participants is a bull flattener.