"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Friday, May 31, 2013

"Houston, We have a Problem!"

In this case it might be better written, "FOMC, we have a PROBLEM!"

What I am referring to is the long awaited and long expected, I might add, breakdown in the US long bond. It is my opinion that the US bond market is the single most important market on the planet. For years, many of us have sat and watched as bond prices were driven to levels that very few thought imaginable a decade ago. What with the rush into the perceived "safety" of US Treasury debt and the concerted effort by the Federal Reserve to drive down long term yield through their Quantitative Easing programs, bond bears were blasted from one defensive position after another by the steady influx of money flows.

My oh my how things have changed over the last few weeks! I give you a weekly chart of the long bond where you can see the breakdown in vivid terms. With the advantage that comes from some hindsight now that enough time has passed to trace out a definitive chart pattern, we can see the peak in the bond market, and the low in long term interest rates has come and gone. Do you see that MAJOR TOP that form over the course of most of last year? Three times the bonds were shoved into that region and three times they failed there. The third time turned out not to be a charm and out went speculative money to giddily chase equities as this bond bubble burst and the new one formed in equities.

Once the major support level gave way near the 145 level, a countertrend rally developed that took bond prices through NINE handles before speculators could see that the final rally to retest the former peak could not muster enough strength to move the final 4 handles needed to reach it. Down she went and up went long term interest rates as a result.

I want to point out something on this chart that is more a function of the rolling process that occurs in the futures markets but nonetheless leaves it mark upon the technical price charts. This week the front month bond contract became the September bonds. Prior to this changeover it was the June bonds. There is currently a FULL ONE POINT DIFFERENCE between the value of those two contract months. When a continuous contract is drawn out for analysis purposes, the data it will include always contains the FRONT MONTH contract or the most active. That has now become the September Bond contract. When this is included, you can see the impact on the technical price chart!

Note how the support level that formed where the counter trend rally began, has now given way because of the level at which the September bond contract is currently trading.

The day is not over yet and thus neither is the week, but barring a late session upside movement in the bond market, it is now on track to close below what has been a significant chart support level. If it does so, odds favor a furthering of the new trend to the downside with no significant chart support showing up until another 3 - 31/2 points lower down near the 136 region.(Maybe the boyz at the Fed will send their New York desk buyer to the market to buy some bonds later today....)

One has to wonder if this is what the Fed had in mind when they were attempting to push long term interest rates lower. What they got was a mad rush out of bonds and fixed income in a near ZERO interest rate environment and into equities. All that money flowing out of bonds in search of easy gains in equities has now resulted in a surge higher in interest rates at the back end of the curve.

It is no secret that the formula for the current "recovery" has been ultra low interest rates which have made debt servicing easier for business, consumers and the government I might add. The big question is whether or not this nascent recovery can stand a rise in interest rates. I do not believe that it can. So where does that leave the Fed?

Talk of tapering QE makes investors nervous and actually undercuts any reason to buy bonds since a major buyer has been removed if that were to occur. That engenders selling. On the other hand, if the Fed were to actually reverse course and RAMP UP bond buying once again if the economy were to slow, then all that would do is to further facilitate the bubble in the equity markets that they have created. Money flows would continue to exit bonds and find a home in equities. Either way, bonds suffer as a result and head lower.

Talk about a self-inflicted conundrum! Good luck with this one fellas... You made it; now handle it!