By LM Lupo, published 1.31. 2007 100am

Bonds to Rally

If the Feds stand pat with respect to rates, as we expect, how does that create a bullish bond market?  We have four primary business drivers that should support higher bond prices in the coming quarters.

First, the interest rate complex is an excellent place to be for overall capital preservation during market consolidations, which we are currently experiencing.  Second, the economic fundamentals support lower rates throughout the entire curve. We are not exactly tearing up growth numbers in case the obvious needs stated. 

Third, the Feds and the market have been slow to catch on to the bigger picture of inevitable liquidity contraction, which we view as a positive for bonds.  Finally, the yield curve, equity bearish for the past several months, will eventually resolve in the favor of bond bulls with lower interest rates in the near future. 

Eventually,  the capital markets will demand some "instrument" of investment, and with commodity prices lower, and equities fully valued and then some, where will the money go?  Interest bearing instruments, of course.

Level Of Confidence

We obviously have a high level of confidence for the bond bias scenario.  We are encouraged by the out- performance of bonds versus other instruments over the past few months even though bonds have been range bound, as we expected. 

Not very scintillating for the capital gains investors--there goes the get rich quick reader--but prudent from a risk-reward position.  The Feds will continue a very conservative monetary posture that will eventually drain the liquidity from the merger and acquisition markets and equities in general.  It always happens that way--barring a crises, then it happens sooner. 

Wrapping up the fundamental scenario, given that very few brokers profit from bond sales, is it any wonder that bonds are rarely recommended as the asset of choice.  Who makes money on Wall Street then? 

Technical Analysis US Bonds

Bonds Greet 5% Yield With Disdain

The long bond market has traded back to the 5% support level, which is  well within our prior established ranges from back in October.  What we find interesting from an historical perspective is that fear continues to mount for higher rates.  This is positive for bonds as the market is concerned about runaway rates, a wall of worry so to speak.  

An Oversold Market Approaching Support

As the weekly 30 year bond chart reveals, prices are now beginning to challenge previous support layers near 109 in the futures contract and roughly 5% on the long bond.  The selling momentum has stalled based on a number of oscillators and solid buying support has emerged.  It won't take much of a catalyst to propel bond prices higher from here.  There is no better catalyst than our friends the Feds.

We maintain our positive bias towards bonds and look for unexpectedly higher returns versus other asset classes such as stocks and hard assets, particularly in the first half of 2007.

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