There is a saying in commodities, "The cure for high prices is high prices." We think that mantra can also apply to U.S. Treasuries, particularly in a world in which investors are sitting on sidelined money. The cure for high yields will eventually be high yields.
We've already seen money flow into the short end of the curve, but we believe it is only a matter of time before we see the same type of motivation to allocate funds to duration. After all, Treasuries on the long end of the curve offer attractive yields and have built-in insurance against stock and economic risk. Yet, even without economic turmoil, the potential risk of a melt-up in this arena is substantial.
According to the Bullish Sentiment Index, only 30% of market insiders polled are bullish on the 30-Year Bond future, and a mere 26% are bullish on the 10-Year Note. Additionally, the Large Speculator category of the COT Report (Commitments of Traders Report issued by the Commodity Futures Trading Commission) has amassed an unhealthy short position.
We recognize that a cyber event at one of the software vendors used at multiple brokerages has caused severe delays in the COT Report, so the data is not as current as it would typically be. Yet, we doubt the recent bond rally has put much of a dent in the net short position. Also, even if it has, the last report was dated a month ago; prices have slid since then before rebounding.
Thus, we suspect the net short position large speculators hold is between 550,000 and 600,000. This is the second largest net short position held by this group. The largest (about 750,000 net contracts) occurred in late 2018 and was followed by a two-year rally in the 10-Year Note.
Chart Source: Barchart
The correlation between the U.S. dollar index and the 10-Year Note is running hot at roughly 96% inverse (they are closing in the opposite directly 96% of the time). This means the dollar index rally will need to run out of steam sooner rather than later to allow the Treasury market to press higher as we expect. In other words, a continuation of the dollar gains could prolong the Treasury correction.
According to our weekly chartwork, we see significant resistance near 106.00 and 107.00. Failure of the dollar rally will put Treasury bears on notice, but it will also be the precursor to an everything rally. A lower dollar and lower yields will encourage money to flow into equities, precious metals, and even most commodities.
Chart Source: QST
Buy June 10-Year Note Call Options
Buy June 10-Year Note 113 CALL @ 50
Total Premium Paid: 50 ticks or $780 plus transaction fees
These options expire on May 26th, with 78 days to expiration
Margin = $0
Risk: Limited to the cost of entry (about $800)
Maximum Profit: Theoretically unlimited above 113'0
