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7/2/2009

My Bond Strategy For Payrolls

6:30AM New York time. Today is a big day. And as always, with Payrolls, it will be where we settle at the end of the day rather than where we trade during the day that will tell the story. 10-year notes sit just off their recent yield lows, just above the psychological 3.5% level, and just under a fairly substantial down-trend line that can be draw from the March high and through the May high. So if the number comes out exceptionally weak, then that trend line will be vulnerable, yields could blow down through the 3.5% level, and the bond bulls will have people like me on the ropes. Conversely… the reverse is possible as well. We could rally bonds on a weak number and then reverse intraday. We’ve see that plenty of times too. It all boils down to daily action, and where the market closes. That will tell us what the underlying propensity is of net bond participants at these yield levels and with our current fundamental backdrop. Obviously… I have made my bet. Since I can’t do anything about the number, my focus needs to be more on preparedness and strategy. The worst-case scenario would be; the number is weak and bonds rally, holding on to gains into the close. In that case, I guess I lighten up a little bit at the close, just for the disciplinary aspect. The second scenario would be, the number is weak, bonds rally, but reverse lower by the end of the day. If that scenario comes to pass, then I plan on pouncing on the weakness, and taking my position up to full risk levels by the close. To me, this would actually be the most bearish behavior for the market. This would also be the best scenario from a trading aspect. It would confirm the market’s bearishness and yet wouldn’t have me selling the market in the hole. The third scenario is that the number comes in less-bad, bonds sell off, and hold their weakness into the close. I would probably sit that sell-off out. While I only have a little over half my position on, the reality is, we will have many little short–term rallies even after the “top” gets put in. I have no desire to sell bonds on a big down day. When I say I want to put the rest of my position on on weakness, that really means I want to sell the little bounces after the 3.47 yield low is confirmed. The final scenario, and the one that leads me to stay away from selling INTO a Payroll induced sell off, is the possibility of a reversal on the day from an early down move on a “less bad” number. Given the history of market reaction to Payroll releases, such an outcome is not beyond the realm of possibility. Bonds have shown quiet a bit of resilience this week. Several times it looked like the sell side was gathering momentum, only to have the market get bought and come right back. I’m bearish… but I’m not suicidal.

OK… so that’s my word on bonds. What about the Dollar? The Dollar has actually been comparatively much weaker Treasuries. I guess I’m not as beared-up on the Dollar as I am on bonds because I see things in the currency as less quantifiable. This is another one of those trading rationalities we all use. In theory, I should be more bearish the markets that act the worst. In reality, I typically feel better selling into a market that has bounced, rather than one that I fear MAY bounce. Weak markets don’t give that entry on strength. They force me to sell weakness. For a contrarian such as myself, that is often the harder trade. And yet… the inability to rally is the single biggest indicator of underlying selling pressure. Weird. I am slight UNDER half exposed in my Dollar Index short. I need to work that position back up to proper risk size as well. I think we eventually see new lows and another run to the downside. As for specific strategy, it will be largely coincident with my 10-year strategy. I would love to get a reversal to the downside to sell. I will resist chasing a move lower. The dynamics of the relationship between the Dollar and the US economy is somewhat different for the currency that it is for Treasuries. A less bad number intuitively should be good for the Dollar. But the evidence of the last year or more shows the reverse. That’s because of the dominance of the risk-aversion trade. That is… as evidence mounts that the economic downturn is moderating, risk tolerances from global participants go up, and money flows back out from safe havens (Treasuries and the US Dollar) to more risky, higher returning assets, such as stocks, emerging markets, commodities, and corporate bonds. One negative for the risk aversion trade, is the recent stall in US equities. In the early days after March 9th, stocks had a much greater impact on Treasuries and the Dollar. The rally was new, and participants were WAY under invested. Now, the rally is much more mature, the position skew has been corrected (perhaps even tilted to the long side), and far more needy of evidence that things actually ARE getting better in the economy. So that factor is no longer there to help Treasuries and the Dollar lower. It doesn’t mean it can’t happen, it just means it won’t develop as easily. OK… that’s enough for today. Best of luck to everybody and enjoy the long holiday weekend.

Steve Plant

FXA

Please email Steve Plant with any questions or comments

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