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Selling TIPS, Buying Junk—What’s Next for Bonds

|Includes: HYG, iShares 7-10 Year Treasury Bond ETF (IEF), JNK, PST, TIP

It has been a rough five months in the bond market after the Treasury bond futures formed a negative “gravestone doji” at the end of August. This candle formation is often seen at major tops. The T-bond futures are down 14.2% from their highs while the iShares Barclays 7-10 Yr Treasury Bond Fund (IEF) topped out in October and is down almost 17%. Even the Treasury Inflation Protected Securities (OTC:TIPS) market has not been immune, as the iShares Barclays TIP Bond Fund (TIP) is down 6% while the high-yielding iShares iBoxx High Yield Corporate Bond Fund (HYG) is up 3.7% from the November lows. After the successful ten-year auction on Wednesday, the market is holding its breath for the 30-year auction later today, which may set up a trading opportunity.

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Chart Analysis: From a technical standpoint, the ProShares UltraShort Lehman 7-10 Year Treasury ETF (PST) looks better than the ProShares UltraShort Lehman 20+ Year Treasury ETF (TBT). The daily chart shows that PSP just completed a nice continuation pattern last week (boxed in blue) as PSP gapped to the upside and moved through its short-term downtrend.

  • The 50% retracement resistance now stands at $45.40 with the 61.8% resistance at $47.20
  • If the rally from the lows at point 3 is equal to the rally from point 1 to 2, the 100% equality target is at $48.20
  • The daily on-balance volume (OBV) has confirmed the recent breakout and is holding above support (line c) and its weighted moving average (WMA)
  • The lower close Wednesday could set the stage for another day or two on the downside
  • Initial support at $43.46 with the 20-day exponential moving average (NYSEMKT:EMA) at $42.71

What It Means: The technical action in the bond market suggests that a major trend change may have occurred, as the long-term downtrend in yields for the 30-year bond has been broken. In this week’s Trading Lesson, I’ll focus on the outlook for interest rates. To receive a copy, please sign up here.

How to Profit: This afternoon’s Treasury auction could push PST back to first good support. If PST has indeed formed a significant low, then the next rally should exceed the rally from $38.03 to $44.28. Traders should buy PST on a pullback to the $42.90-$43.34 area and place a protective stop at $41.36. On a move above $44.60, raise the stop to $42.90 and sell half the position at $45.21.