Tuesday, September 20, 2011

Encouraging action for bond bulls

Back on August 29, I wrote that it was not too late to buy the long bond and I remain relatively comfortable with that position, despite the likely volatility from the FOMC meeting this week.

For several weeks, traders have been frustrated as stocks and bonds appear to be stuck in a volatile news-driven range bound market.

While that may be true of stocks, the long bond yield fell to 3.19T yesterday, which is good news for bond bulls. The chart below shows the yield on 30-year Treasury, which is in a downtrend and staged a minor and unconfirmed downside breakout (upside price breakout).

While I recognize that the bond market rally may be in anticipation of the implementation of Operation Twist, this market action is nevertheless constructive for bond bulls. In addition, Maryann Bartels of BoA/Merrill Lynch reported that large speculators, which are mostly hedge funds, have a roughly neutral position in the T-Bond futures contract - indicating that the hedge fund/fast money doesn't seem to be positioned in anticipation of Operation Twist:

(Note that this data is a little dated from last Tuesday, September 13.) What's more surprising is that large speculators were near a crowded short in the 10-year note:

Bartels also reported that global macro hedge funds were net short the 10-year note, which is another indication that macro hedge funds are not frontrunning Operation Twist.

As well, Arthur Hill of stockcharts.com pointed out that industrial metals broke down through a technical support level yesterday, which is a signal of economic weakness - and another positive sign for bond prices.

Looking ahead to the FOMC meeting
While I am acutely aware of the event risk on Wednesday from the FOMC meeting, I agree with the analysis of Tim Duy. Underlying his assumption is the Federal Reserve is an institution of economists, who are mostly academically inclined, and not just one person. While Chairman Bernanke's opinions no doubt carry a lot of sway, he is not king.

I believe that the most likely outcome is some form of extension of the average maturity of the Fed balance sheet, along with an improved communication policy from the Fed in order to makes its decisions more transparent.
Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.
None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.


WimpyInvestor said...

Would you consider LQD as part of "risk on" or "risk off" basket in the current environment (e.g., low rates until mid-2013)?

Betting on the credit spread tightening is clearly "risk on", but rally in "risk free" US treasuries (lower yield = risk off) has actually helped LQD trade to new highs ...

Can LQD be the new "risk free" asset class (less inflation risk, less deflation risk)?

The volatility in LQD vs. 10-Year Treasuries has been lower in recent months / quarters ... so, can we view it as a new "safe haven" asset class?

Appreciate your thoughts.

Humble Student of the Markets said...

I am afraid not.

LQD underperformed IEF during the Lehman Crisis and it has underperformed IEF in the past month or so. In a panic, people want return OF capital instead of return ON capital and only the Treasury can provide that margin of safety.