Tuesday , 18 June 2024

These 5 Trends Suggest It Is Time to Short Bonds NOW!

As the fiscal cliff is nearing with the end of 2012 in sight and total public debt approaching the debt limit of $16.4 trillion, investors need to seriously start worrying about the U.S. bond market. [Below are 5 trends that support that view.] Words: 599

So says Katchum (http://katchum.blogspot.ca) in edited excerpts from his original article* posted under the title Short Bonds Now!

Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), may have edited the article below to some degree for length and clarity – see Editor’s Note at the bottom of the page for details. This paragraph must be included in any article re-posting to avoid copyright infringement.

Katchum goes on to say, in part:

Technically, the bond yields on the 10 year treasury notes are bottoming out. We could see bond yields rising and bond prices collapsing….[based on the following trends].

30-year Fixed Mortgage Rate Trend Suggests…

Aside from the rising debt and the fiscal cliff we should note first that 30 year fixed mortgage rates have hit a new high of 3.5% and are, on average, at 3.4%. As bond yields follow the mortgage rates closely I expect bond yields to go up too.


Chart 1: 10 year U.S. bond yield


Open Interest Trend Suggests…

Further evidence of a coming bear market in U.S. bonds can be found on the open interest front. Historically, when commercials are net short the bonds, bond prices will show weakness going further. This can be seen on Chart 1 versus Chart 2. When the bond yields go down on Chart 1, the net open interest will tend to go to the short side (red curve goes downwards on Chart 2). At the same time, when bond yields go up, the net open interest will go to the long side or upwards. The only time this correlation didn’t hold up was during the economic crisis of 2008 where bond yields were artificially suppressed.

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As we see today, the short interest is at a record high (red curve on Chart 2 makes a dip). If we see the red curve move upwards, while commercials start to get long treasuries, we will see U.S. bond yields go up.


Chart 2: Commercial net exposure (long = +, short = -)


Non-commercial Open Interest Trend Suggests….

Likewise, we can analyse the non-commercial open interest, which is actually the opposite of the commercial  open interest. The speculative long exposure to 10 year treasuries is at an all time high of 170000 net contracts. This indicates to me that we are approaching ” bond bubble” territory, especially at these low yields.


Chart 3: Non-Commercial net exposure (long = +, short = -)


U.S. Stock Market Trend Suggests…

There is a good chance that we will see decoupling. The stock market is already showing significant weakness, shedding 10% in a few weeks due to an overvaluation/outperformance in the U.S. stock market, the U.S. bond market is overcrowded and is likely to fall, and the U.S. dollar cannot stay strong as QE3 is about to start, in order to put a cap on rising mortgage rates and bond yields.

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Federal Reserve Balance Sheet Trend Suggests…

The Federal Reserve did not execute QE3 as promised in the month October 2012 as can be seen on Chart 4 (the balance sheet’s assets remain flat) but, considering the weakness in the stock market, bond market and mortgage market, we could soon see the Federal Reserve jump starting the printing presses.

Chart 4: Federal Reserve Balance Sheet

Moreover, do not forget that Operation Twist II is ending at the end of December, 2012. From then on, the Federal Reserve needs to buy U.S. Treasuries outright and then we will see their balance sheet expand while the U.S. dollar devalues.


Investors can prepare for a bear market in bonds considering all the evidence I pointed out above. I don’t recommend shorting bonds via ETF’s. Instead, it’s better to go for the gold trade as the Dow/Gold ratio is quickly declining at this moment. Historically, gold and treasuries go the opposite ways.


Editor’s Note: The above post may have been edited ([ ]), abridged (…), and reformatted (including the title, some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. The article’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article.

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