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Is the Bond Market a Bull Trap?

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Banks have exited the Treasury market, leaving speculative money and a lot of risk. There is more speculative money in the 10-Year US Treasury Note than there was in March 2008.

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For example, the T-note rally in 2010 produced a maximum yield of 4% with a maximum increase in NAV (net asset value) of 11%. The T-note rally in 2011 produced a maximum yield of 3.74% with a maximum increase in NAV of 11.88%. The T-note rally in 2012, however, produced a maximum yield of 2.39% with a maximum increase in NAV of only 6%. Since its peak on June 1, 2012, the T-note has faltered, reaching a break-down point on September 13, 2012. The banks (and the Fed) must have seen the writing on the wall by the time QE3 was announced.



The Bull Trap Is Set

As you can see on the chart of the 10-Year US Treasury Note, the bearish wedge formation lower trendline was broken just prior to the Fed's QE3 announcement. This appears to have been a signal for the commercial banks to exit, leaving the speculative crowd attempting to "front-run" the Fed after its announcement.

That is exactly what has happened in the bond futures market. As of two weeks ago, the speculative long exposure in the 10-year Treasury notes had more than doubled from 79,296 net long contracts to 169,456 net long contracts. This is the highest speculator position since March 2008! The futures market is a zero sum situation, i.e., for every long, there is a short and vice-versa. The commercial banks are now net short by the same amount as the speculators are long.

It is noteworthy that the T-Note index has not been able to break above the trendline of its bearish wedge for the past month. On the other hand, a reversal below its 50-day moving average shown on the chart at 132.61 may have severe consequences for speculators owning T-notes. In addition, any downgrade of the federal debt would also have grave consequences for bond and note holders.

The rise in yield would not offset the loss in net asset value for a very long period of time. We consider this to be a warning shot over the bow for those who have, for so long, sought shelter in the "relative safety" of Treasury bonds and T-notes.

See more from Anthony M. Cherniawski at The Practical Investor, and more from Janice Dorn, M.D., Ph.D. at Trading With Art and Science.
No positions in stocks mentioned.
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