January 5th, 2009

When it rains it pours.

Yields have skyrocketed in recent trading sessions as the flight to quality demand for ultra low return Treasuries has finally dissipated.   The Treasury "bubble" has been a perfect example of a market's tendency to overshoot fundamentals.  The economic and monetary policy today is nearly identical (or maybe even slightly more bond friendly) than it was on December 30th before the massive slide.  To put the move into perspective, we have witnessed a nearly 10-handle plummet in the previous three trading sessions.  so far the fall from grace has been even steeper than the one-way rally. 

Economic data was relatively sparse during the session, but we did get some information on construction spending.  Actual spending was a little better than projected, but still in negative territory.  Nonetheless, it wasn't enough to thwart the intense selling on the long end of the curve. 

Bailout and TARP rumors continue to circulate and are now putting pressure on fixed income securities as safety buying has all but dried up.  As the Fed floods the market with liquidity, concerns of inflation begin to heat up.  We have been discussing the fact that this realization was imminent but timing it was difficult. 

Also weighing on prices is the idea that with yields at such low levels, the supply of long-term maturities is anticipated to increase dramatically.  This makes sense as the government is being enticed by the need for funds and low borrowing costs.  There is even chatter in regards to the Fed issuing maturities of 40 years or more, this too is lifting some of the demand for the T-Bond.  Once again, many analysts and traders saw this phenomenon developing (including this newsletter) but the timing seemed questionable in the face of a runaway Treasury train.  If only we knew on December 30th, what we know now...

In previous newsletters, we noted a target in the March 30 year bond at 131 and we still feel this way.  We are also maintaining our opinion of the 10-year note drifting lower to about 122.  Who knows, maybe we will even  be short-term bullish at such levels...

Treasury Bond and Note Option Trading Recommendations

**There is unlimited risk in naked option selling.

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Treasury Bond and Note Futures Trading Recommendations

**There is unlimited risk in trading futures.

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Eurodollar Futures Trading Recommendations

**There is unlimited risk in trading futures.

December 17 - Clients were recommended to Sell March futures near 98.84 and buy the March 9875 call for 21.  The total risk is $300 plus commissions and fees (2 of them), profit potential is theoretically unlimited, and this trade gives you three months in the market!

*Due to the volatile nature of the futures markets some information and charts in this report may not be timely.

There is substantial risk of loss in trading futures and options.