Bond Prices Buoyant ahead of NFP report

Fundamentals

"The news of my demise has been greatly exaggerated." Borrowing this phrase from Mark Twain appropriately describes the bull market in U.S. Treasury bond futures. Since April of this year, lead month bond futures have rallied over 13 full points, as investors and traders moved into so called "safe haven" investments. The economic recovery seems to have hit a speed bump, as uncertainty over the sustainability of the Euro and weaker than expected U.S. economic data, as well as signs that the Chinese economy is beginning to slow have sparked fears of a potential "double-dip " global recession. Austerity plans involving higher taxes and spending cuts were the biggest announcements out of the recently held G20 meeting in Toronto, as European leaders attempt to rein in large government deficits. However, there are fears that this plan for "fiscal discipline" could be the "medicine that kills the patient," shutting down the economic recovery before it was strong enough to be sustained without the massive government stimulus that has been in place. In addition, the recently released Chinese PMI reading came in worse than expected, signaling to some that the "economic juggernaut" may finally show some signs of slowing economic growth. This report sent commodity prices falling -- especially base metals and energies -- as any signs of weakening demand from China is typically viewed as bearish for commodities in general. With traders' minds starting to drift towards a long holiday weekend in the U.S., focus must be kept for a few more hours, as we still have the release of the monthly Non-Farm Payrolls report for June this morning. Average analyst estimates are for June payrolls to contract by about 100,000 jobs, as temporary workers hired for the U.S. census are let go. However, some traders fear an even higher number of jobs lost may be announced, especially given the weaker than expected private sector jobs figures released by ADP this past Wednesday, as well as a larger than anticipated rise in jobless claims for the final week of June. So unless with get a "positive" surprise in the unemployment report, bond bulls will be reluctant to liquidate their long positions ahead of the Independence Day holiday.

Trading Ideas

With bond futures trading at their highest levels of the year, bulls are definitely in the driver's seat. However, technical traders will note the September futures are starting to look a bit over bought. Some traders who anticipate a large move for bond futures but are unsure as to in which direction the move will occur may choose to explore a trading strategy that would benefit from an increase in volatility or a big move in the underlying futures. One such strategy would be the purchase of a strangle in bond futures options. An example of such a trade would be buying the September bond 130 calls as well as buying the September bond 122 puts. With September bond futures trading at 127-26 as of this writing, this strangle could be purchased for about 3-20 points, or $3,312.50 per spread, not including commissions. The premium paid would be the maximum risk on the trade, with the trade profitable at option expiration in August should September bonds be trading above 133-10 or below 118-22.

Technicals

Looking at the daily continuation chart for bond futures, we notice the market break-out to the upside once prices moved out of the consolidation pattern formed in early June. Prices are now above the 20-day moving average, which looks to have triggered additional momentum buying. If there is one potentially bearish indicator, it is the bearish divergence forming in the 14-day RSI, as this indication has failed to make a new high reading despite September bonds trading at yearly highs. 129-00 looks to be the next resistance point for September bonds, with support found at the 20-day moving average, currently near the 124-24 area.

Mike Zarembski, Senior Commodity Analyst