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A 2013 Bond Market Prognostication: Why a Breakout Appears Likely


Plus: What are the levels to watch next year?

MINYANVILLE ORIGINAL The holiday season is mostly a time for giving and gluttony, but it can also be a time to reflect on where the markets have been and where they could be going. In joining with the time-honored tradition of providing prognostications for the New Year, I wanted to reflect on where the bond market has been and where it could be going.

On Friday, the 30-year US Treasury bond (a.k.a., the long bond) yield closed at 2.93% and is poised to close the end of the 2012 right on top of where it closed the end of 2011 at 2.895%. I can say with almost absolute certainty that while I don't know where the long bond yield will close in 2013, I know it won't be at 2.90%.

Closing unchanged for consecutive years for the long bond -- which is the most volatile US Treasury security -- is an extremely rare occurrence over the past 30 years. In 2001, the long bond closed at a yield of 5.466% after closing 2000 at 5.457%. In 1992, the long bond closed at 7.396% after closing 1991 at 7.40%; in 1988, it closed 8.99% after closing 1987 at 8.978%.

The obvious conclusion for why the long bond yield would be closing the year unchanged is that Federal Reserve policy has been actively holding interest rates artificially low via Operation Twist and quantitative easing. With last week's FOMC announcement of what is basically an open-ended QE that will be targeting economic "thresholds," I think the general consensus believes that they will be able to keep these thresholds at these levels. However, upon further examination, it's my belief that market price is saying something different.

I think one of the biggest mistakes investors make when analyzing the bond market from a technical perspective is they get caught up looking the pattern of bond yields -- or worse, the long duration ETF, the TLT. Back on September 10, I addressed this in The Most Important Market No One Is Watching, when I advised investors to instead focus on the US 30-year bond futures, which I called "the contract."
There are legions of self-proclaimed "macro" strategists and hedge fund managers who cite and trade the bond ETF (TLT). It's one thing for a retail investor to trade TLT, but there is no self-respecting bond strategist or fund manager that has even ever uttered the letters TLT. Trust me, you will never see CRT's David Ader cite TLT and you won't see Paul Tudor Jones trading it. If you want to know what the bond market is doing, you have to watch the contract.

Friday the contract did its thing. Watching the price action pre and post NFP, there was no disputing which way the speculators were leaning, and when they covered on the gap, there was no bid behind. Casual market observers like the New York Times brush off the price action as irrelevant to the story, but I am here to tell you it's the whole story.

Since the miserable June NFP that only saw 45K jobs added, the contract (Dec now front month) has been confined to a range with the big pivot at 150-00, which is the same level that was tested in Thursday and Friday's intense volatility. This is not a random coincidence. The market is battling in here.

I have been monitoring the 150-00 level on the US bond contract for months and it has continued to act as the main pivot consolidating the market since the disastrous May NFP number on June 4. Most recently, the 150 level rejected an attempted retrace on December 10, which was the Monday after the November NFP data that saw the contract gap down through it to 149-16. Since then, the long end of the curve has been for sale despite the Fed's announcement of virtually unlimited Treasury purchases when Operation Twist expires at the end of the year. This past week. the bleeding finally stopped with bond prices finding some oversold support at the psychological 3.0% level on the long bond and the 1.80% level on the 10YR.
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