Buying Opportunity on Bond Washout

We’ve been watching the Bond markets closely over the last few weeks. We were ahead of the curve in our discussion of negative interest rates among G7 countries and had already issued trade alerts within this segment prior to Bill Gross’ announcement of the German Bund being, “the short of a lifetime.” The purpose here is not to tout our own research but to provide you with one of the primary tools I use to stay ahead of the markets and the news.

Our specialty is the adaptation of the weekly Commodity Futures Trading Commission’s (CFTC) Commitment of Traders (COT) report for use on daily data. We’ve plotted the net commercial traders’ position in the second pane of the included chart. We track their actions both in actual number of contracts in their position as well as the pace of their buying and selling. Ultimately, the idea is to ascertain how eager they are to take action at a given price level and put their actions to work for our trading positions.

Commercial bond traders have been heavy buyers on the Bond market's decline through major technical support.
Commercial bond traders have been heavy buyers on the Bond market’s decline through major technical support.

The commercial traders have been very active as the Bond market churns near what many feel may be the all-time high. Others, however feel that the European Central Bank’s version of Quantitative Easing, which is just beginning, will continue to artificially depress yields.

Lets take a look at what they’ve done. The first highs made in late January had been pushed by December’s commercial trader buying of more than 70k contracts. Their sentiment shifted to neutral as they sold off some recent purchases. Most importantly, the March highs met with considerable commercial selling pressure which may have capped the rally short of the highs and created a technically weak, double top or, bearish divergence formation. Commercial trader selling along with the weak technical outlook clearly helped force the market through the support near 154 1/2. Furthermore, the market’s decline of more than 9% from the April highs through this morning’s low has been deep enough to washout many long-term trend followers.

Currently, we have a classic commercial trader buying setup that bodes well for a speculative short-term trading opportunity. Commercial traders have been covering their shorts on this decline at a rapid pace. In fact, their eagerness to buy the market here has now shifted their momentum to the positive side of the ledger. Using them as a backstop, I will be using today’s capitulation to go long the 30yr Bond futures. Whether the generational highs are in or not, I’ll be happy with a run back to 159-160 while limiting my initial risk to this morning’s low of 151^04.

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