Bond Spreads Paint Bleak Economic Picture

We’ve been tracking the interest rate complex even more closely since October when we saw the commercial traders beginning to place their bets ahead the Federal Reserve Board’s (FRB) December meeting and while we’d like to take credit for the predominantly correct calls in the interest rate sector through 2015, we really have to chalk it up to knowing who to follow. The commercial traders have done a great job of anticipating both the FRB’s actions and the market’s reactions. Join us as we determine how their recent actions have affected the bond markets and what the spread movement in this market sector could mean to the broader economy going forward.

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Interest Rate Futures at Odds with Federal Reserve

There’s a saying that’s been around a looong time in the domestic interest rate and stock markets. Although it was once nearly forgotten, it’s come back with a vengeance since the 2009 collapse. DON’T FIGHT THE FED. Ring a bell? The Federal Reserve Board (FRB) here in the US has been the leader in extricating the world’s economy from the depths of despair. Their policies, whether right or wrong, have put us on the leading edge of the global economic landscape. Two things have happened as a result of this. First, the US now finds itself dragging along the global economy because the FRB’s practices have placed the US ahead of the global recovery curve. Secondly, because we’re now ahead of the global recovery curve, the first rate hike in years is being taken for granted as global pressure suggests the FRB may have acted too soon. The reality of this is the trade setup in the interest rate complex as shown below.

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Commodity Based Stock Play

Our business focuses on the commodity complex. We rely on the Commodity Futures Trading Commission’s (CFTC) Commitment of Traders report to sort out what the major players are doing in the commodity markets. Our focus lies with the commercial trader category of this report. These are the traders who either have the commodity to sell or, will be using the commodity in their manufacturing processes. Following the commercial traders category, as a whole, for a given commodity can provide us with a consensus opinion from the world’s largest producers and end users of a commodity. There are times, like now, when their collective actions in the commodity markets can pay direct dividends to equity traders, both in individual stocks as well as commodity based ETF’s.

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Stock Indices Bottom at 2015 Lows

Most of our trading is based on the consensus opinion of the commercial trader group as reported in the weekly Commitment of Traders report. We track their behavior in a couple of different ways but the simple conclusion is that we want to buy when they’re buying and sell when they’re selling. You’ll see the net commercial trader position plotted in the second pane of the stock index charts, below. We measure their actions on a sum and momentum basis. This allows us to determine how anxious the commercial traders are to get their trades executed at a given price level which, in turn, tells us a lot about the importance of a given area. Obviously, the previous year’s lows are an important area. Based on the collective actions of the commercial traders across the major indices, we’ve issued a COT Buy signal.

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Commitment of Traders Report Points Towards Cheap Sugar

We’ve suggested that the recent rally of more than 50% since August 24th in #11 sugar futures is unsustainable, even to the point that we sold the market early in October in anticipation of its failure. As usual, the market told us exactly what we could do with our, “suggestions.” Fortunately, the consolidation between November and December has provided us with another chance to short the market. This time, perhaps even more decisively thanks to increased commercial trader selling as reported by the CFTC in its weekly Commitment of Traders report.

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US Bonds Little Changed in Spite of Chaos

The Federal Reserve has hiked interest rates for the first time in years, China is falling apart and tensions continue to grow between Saudi Arabia and Iran. The combined chaos these events have generated have moved the 30-Year Treasury Bond futures less than one handle over the last year. In fact, the converted yield on the 30-year Treasury Bond futures has risen .0726% over the last calendar year. Therefore, in spite of the noise in the markets, the reality is that not much has changed.

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Commodity Futures Trading