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Top in Bond Futures

Chart 1- Monthly CBOT T-Bond Futures

In our first chart, you can easily see that a potential long-term diamond top chart pattern is in the making. At present, this is a technical analysis textbook situation as a very long-term bull market in bond prices precedes the diamond top formation. Thereby, possible setting the tone for a long-term bear market.

Chart 2 - Monthly CBOT T-Bond Futures

In this chart, I have annotated two minimum Fibonacci projected lows for a potential a bear market. If you look to the right side of the chart the project highs utilizing Fibnoacci projections within the bull market were about dead on the money. Personally, I found it to be a little creepy.

Chart 3 - Monthly CBOT T-Bond Futures

In our last monthly chart a potential long-term symmetrical triangle continuation pattern is now forming. Additionally, I have annotated examples of these types of continuation patterns within the bull market of the 80’s and mid 90’s.

Chart 4 - Monthly CBOT T-Bond Futures

On the intermediate-term time frame, bond futures have recently broken down from a head-and-shoulders top as well as a symmetrical triangle. Please keep in mind that while flags/pennants usually appear as trend continuation patterns they can also from time to time mark market tops/bottoms.

Chart 5 - Daily June 2006 CBOT T-Bond Futures

On the short-term front bond futures have recently broken down through a small bear flag. However, the market is now currently sitting at a monthly pivot support area. Additionally, the market held this area on an intra-day basis on Friday.

Chart 6 - Real Interest Rates (Interest Rates After Inflation)
(3 month T-bill Yields - Consumer Price Index)

Note: For those relatively new to the financial markets a 3-month T-Bill is considered to be equivalent to cash. This is why a 90-day T-Bill is used to calculate real interest rates.

The chart above “Real Interest Rates” shows that real rates went into negative territory in 1974 and stayed there until 1980, ultimately reaching a low of (-3.2%) in 1975. During this entire time frame, the mean was (-1.70%).

Negative real interest rates are not a very common occurrence. However, over the past two years real rates have been negative. At some point in time investors with capital allocated in financial based assets will catch on to the fact that they are playing a loaded game with real interest rates near 0%, let alone negative.

Precious metals bulls rejoice, it now appears that last of the five basic fundamental factors needed for a very long-term bull market in gold and silver could be in place.

One other item to note is the U.S. dollar. At present, foreigners own vast amounts, around half, of U.S. bonds, bill, notes, and corporate debt. A further breakdown of the bond market could lead to further repatriation of capital held by these non-U.S. citizens. Personally, I can very easily see some of this capital flowing into the precious metals sector.

For additional technical analysis of the Euro futures contract be sure to check out a recent post I did on this market. CME Euro Futures

Commodity Futures Trading Weblog Summary:

At present, there are many technical and fundamental reasons for a nasty long-term bear market in bond futures. However, we may see a small bounce from the current levels. But I wouldn’t initiate a long position here. Presently, I would like to see a bounce to the 109-110 area via the June 06 contact.

There is massive resistance in that area which if you study the charts above you can easily spot. With a proper stop for risk management purposes I would not hesitate to initiate short positions at that level.

Single Stock Futures:
Be on the watch for short-based trades in General Motors, Freddie Mac, and Fannie Mae etc. With GM bonds already considered junk status, most likely that will not change even with a partial liquidation of GMAC, and potential toxic derivatives books at Freddie Mac and Fannie Mae these stocks could easily collapse with an increase in rates across the board.

Naturally, it goes without saying, short trades in housing and construction based single stock futures also present possible opportunities.

Old market wisdom has dedicated to us that markets drop in price twice the rate that in which they increase. This is especially true in smaller markets. However, considering the massive liquidity of the U.S. bond market that old rule may not hold exactly true this time around. Under “normal” circumstance bond futures trend to trend both up and down very nicely. Of course there are exceptions to this.

Another item to keep in the back of you mind is a “Long-Term Capital Management event”. A toxic corporate over-the-counter (OTC) derivative hedge book maybe a rouge hedge fund that implodes etc.

Considering the absolutely staggering size, were talking about notional values in the trillions of dollars yes that’s with a ‘T” not “B”, of the OTC derivatives market, interest rate derivative positions are hands down the largest, any “unforeseen blow up” due to a large bear move in bonds could very easily exacerbate “normal levels’ of volatility in financial futures, precious metals futures, and foreign exchange (FX) markets. You can access detailed OTC derivative data, including total notional size and categories, at visiting the Bank For International Settlements (BIS) website.

Are you in need of additional bond futures analysis? Not sure what the impact of higher interest rates will have on your portfolio or how to potentially capitalize on this situation? Could a managed futures account be an suitable for you?