While Treasury Bonds are short-term oversold and have reached levels that have previously provided support (126-00 in the March contract), the market might pause and wait for some important fundamental information in the coming weeks. This market has had some counter-intuitive reactions to classic fundamental developments in the past, including a rush to buy Bonds in the face of hot inflation data and persistent stepwise increases in the US Federal Funds rate. The trade’s reasoning was that the medicine needed to shut off inflation would be overwhelming for the US economy and would result in a recession.
Not surprisingly, the Covid crisis and the accompanying fear of a depression resulted in nearby Bonds posting a 45-point gain from early 2021 to mid-March 2021. This was followed by a three-year, 83-point decline from the pandemic-inspired high that seemed to realign the market to a more rational level. Looking back at that decline, it was not surprising to see periodic recoveries against the downtrend.
In retrospect, we view the 15-point rally from last October’s low to the late January high as normal corrective action that put the market in a better position to resume its long-term downtrend. More importantly, seeing Treasury prices fall 8 points in the wake of a much hotter than expected January jobs report and hotter than expected inflation readings in mid-February confirms the market’s shift back to classic fundamentals.
The hard break from the January high took place after the trade posted its largest spec and fund net short since March 2021. The Commitments of Traders reports have been postponed for several weeks due to a data problem, but we estimate that the net short reached historically significant levels at this week’s low, leaving the market deeply oversold.
We see Treasuries settling into a long-term downtrend but also recognize that the oversold condition could prompt short covering ahead of the US jobs report on March 10. For those looking to sell Bonds, we suggest combining a short futures position with option protection.
Originally Published February 24, 2023
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