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Bond Sentiment



With the recent collapse in Treasury bonds, media attention has been getting increasingly loud as to the rapid rise in yields. By looking at how sentiment is shaping up among various players in bond land, we can get a glimpse into the odds of whether or not the rise in yields will continue.

Several weeks ago, I mentioned the pessimism shown by Rydex traders towards the long bond. At the time, it was already quite extreme, and I suggested that we may see at least a small bounce sometime soon - unless we were indeed seeing the end of that bull market, in which case these ratios could become even more extreme. That has indeed happened, and we are now seeing an almost unprecedented level of bets being placed counting on a further drop in bonds. From a contrarian point of view, this is bullish for bonds.

The CTA's (Commodity Trading Advisers) polled by Market Vane, Inc. have been jumping ship faster than you can say "I'm losing all of my clients' money". In mid-May, 87% of those surveyed by Market Vane were recommending long positions in bonds. That lopsided majority was right for awhile, as bonds came back after a brief dip to make a higher high. However, the collapse since then has apparently caught these "professional" traders off guard, as the bullish ranks have thinned considerably. Over the past few years, when the percentage of bullish CTA's has dropped to 40% - 45%, bonds have bottomed soon afterward. Currently, the bullish percentage is 48%, which is getting close to an area where we might expect at least a bounce in bonds.

Put/call ratios on 30-year bond futures are on the upper end of their usual trading range. High put/call ratios suggest a preference for puts over calls, which is normally seen when traders are pessimistic. Again, from a contrarian point of view that is bullish for bonds. However, these ratios are not particularly extreme at the moment, and put/call ratios on bonds are notoriously inconsistent forecasters.

The Commitments of Traders data for 30-year bond futures, which shows the total long and short positions for large commercial hedgers and other not-so-large traders, is mildly bullish for bonds. I've showed this information before, and when commercial hedgers become net long while small speculators become net short, it has been one of the best signals extant to build up a long position in bonds. Currently, commercial traders are more net long than are small speculators, but neither side is particularly extreme at the moment, which is somewhat surprising considering the move we've seen over the past month. It appears as though both sets of traders are standing back a bit to see how things shake out.

Overall, we're seeing a relatively high amount of pessimism by bond traders. Is it enough to expect a major, long-term (several months at least) reversal in bonds right here? I don't think so, at least not yet. I would much prefer to see commercial hedgers become aggressively long the 30-year futures, at the same time small speculators are making some major-league short bets. I would also like to see a couple more weeks of the sentiment surveys showing extreme levels of bearishness. It might pay for short-term traders to look at some reversal plays in bonds now (especially after today's consumer confidence number, but I would defer to Brian on the implications of that), but on a larger time frame, the sustainability of a bounce here is questionable from a sentiment perspective.

No positions in stocks mentioned.

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