We use the Commodity Futures Trading Commission Commitment of Traders report to generate daily buy and sell signals in the commodity futures markets and Exchange Traded Funds. Our analysis has been featured in many places online and in print and is disseminated nightly via the COT Signals, nightly email.
Thursday, June 14, 2012
Fear and Inflation
The bailout of Spain has begun and the market’s reaction
suggests that it has found little comfort from the 100 billion Euros that have
been allotted to backstop their debt. The initial drop in Spanish yields was
short lived as the market closed nearly where it had begun the day. Immediately
the talk turned to Italy’s ability to maintain serviceable interest rates on
their debt. Followed immediately by Ireland leveraging the situation to their
advantage by seeking to renegotiate the terms of their bailout to match Spain’s
favorable terms. Otherwise, Ireland may simply default. The net result was the
continued evacuation of money from the European Union and into the U.S. Dollar
and U.S. Treasuries. The flood pushed Treasuries to record low yields.
January 3rd Yield Curve
June 11th Yield Curve
We are at a critical juncture in the decades long Treasury
rally and I believe that we are nearing the top. The political unrest overseas
has the ability to accentuate the last leg of this move and create a major
spike high and the CFTC’s Commitment of Traders (COT) reports show
unequivocally that major bets are being placed on both of these outcomes. This
creates the setup for a steepening yield curve going forward as short-term
rates decline on a flight to safety while long-term rates begin to more
accurately reflect the inflationary nature of the monetary policies being
enacted by both the European Union and us.
The major market players’ actions have begun to crystallize
since the beginning of March. This started the Dollar and Treasury rallies in
earnest. We’ve seen a 7% rise in the Dollar and a 200% increase in the
commercial traders’ position. Meanwhile, Treasury price rallies of 4.5% in the
10-year Note and 10% in the 30-year Bond have pushed the futures markets to
record low yields of 2.107% and 2.608%, respectively. These price rallies have
had the full support of commercial traders as they loaded up near the March
lows, increasing their positions by 65% in the 10-year Notes and 122% in the
There are two important things to notice in the preceding
paragraph. First, is the disparity between the price rallies of the 10-year
Note and the 30-year Bond. This provides a feel for how much more volatile the
interest rate picture gets as it moves out on the timeline. Secondly, it
demonstrates how well the commercial traders forecast price swings in the U.S.interest rate futures. Both of these facts are supported by their winning
trading accuracy of 73% in the 10-year Note and 64% in the 30-year Bonds via
the COT Signals nightly trading signals.
Market sentiment and the actions of the large Treasury
traders changed substantially towards the third week of May. This is when it
appeared that the equity sell off might have halted. The tell came when
equities continued to slide into June and commercial traders shed less than 20%
of their long 10-year positions with the expectations of continued low
short-term rates while simultaneously selling off more than half of their 30
year Bond position to match their expectations of inflation in the future.
Successful traders don’t make a living by catching the
reversal of a 20-year trend, nor do they ignore the fundamental thesis of the
politics of the day. The current picture is quite clear that politics must keep
short-term rates near zero as the European banking system absorbs the full
brunt of a panicked public. Traders are also keenly aware that what is borrowed
today must be paid back in the future. Therefore, traders are using the
market’s current volatility to calculate future interest rates that reflect
where the global economies will be, rather than where we are.
Crestmont Research has a wonderful site full of scholarly
research on both the equity and index markets. Part of their research in the
interest rate field shows that the vast majority of times, interest rates will
fluctuate by at least 50 basis points over every six month period at some point
along the yield curve. We’ve already illustrated the volatility of the 30-year
Bond. Putting their research to work for us provides a six-month volatility
envelope in the December Bond futures with a high price of 154^20 and a
corresponding low yield of 2.251% and a low price of 140^06 and a corresponding
high yield of 3.251%. Clearly, commercial traders are signaling their
expectations that the low price, high yield scenario is the one that plays out.
blog is published by Andy Waldock. Andy Waldock is a trader, analyst,
broker and asset manager. Therefore, Andy Waldock may have positions for
himself, his family, or, his clients in any market discussed. The blog
is meant for educational purposes and to develop a dialogue among those
with an interest in the commodity markets. The commodity markets employ a
high degree of leverage and may not be suitable for all investors.
There is substantial risk of loss in investing in futures.