Share:

Compliments of the most aggressive rate hike campaigns in US Central Bank history, we’ve seen a return to high-yield, low-risk assets. Investors have been flocking to the short end of the curve for good reason; the 2-year note backed by the perceived safety of the US government is yielding 5%! However, after last week’s selling pressure on the long end of the curve, the 10-year note and 30-year bond are paying investors over 4%. With the potential for capital gains in addition to yield, this could prove to be one of the best times in history to be a US bondholder.

Thus far in 2023, fixed income, and particularly long-dated Treasuries, have been held back by one of the best starts to the year for stock indices in history which attracted fresh investment dollars that might have otherwise gone toward fixed-income securities.

Widespread expectations for a recession and analyst forecasts for lower equities left investors and speculators on the wrong foot. Traditional investment portfolios were underweight equities coming into the year, and speculators recently held the largest net short position ever recorded in E-mini S&P 500 futures. We have seen most of the bearish speculative bets unwound and price action suggests that portfolio managers and individual investors gave into FOMO mentality (forcing money into stocks at elevated prices).

While we aren’t outright bearish stock indices, we believe most of the gains are already behind us. Since the Financial Crisis, investors have been spoiled with riches by non-stop government stimulus and easy-money policy. After 2009, S&P 500 total returns have exceeded 20%, an abnormally high number of times. Further, with gains of 31.5%, 18.4%, and 28.7% in 2018, 2020, and 2021 respectively, investors’ perception of normal is seemingly skewed. The long-term return in equities is in the 8 to 10% range, not the 20% to 30% range that many market participants appear to expect. This mentality has likely enticed sidelined dollars that would rationally be allocated to Treasuries to make their way into the stock market in search of higher returns. Yet, a normalization in equity returns to reflect the lack of government stimulus would leave a risk-free 4% yield (assuming held to maturity) with a reasonable chance of appreciation looking quite attractive. After all, the current yield for holding the S&P 500 is about 1.5%, with substantial downside risk and minimal upside profit potential.

In addition to simple risk/reward analysis, this premise is corroborated by a few peripheral factors; let’s take a look.

Seasonality

The Treasury market often relentlessly presses higher in July and August regardless of fundamentals. Thus far, the seasonal strength has been non-existent, but there are plenty of reasons for that to change.

Chart

COT report

We are only aware of one other instance in which speculators in the futures markets were as aggressively short the 10-year note futures as they are today. In fact, according to the latest COT Report (Commitments of Traders) issued by the CFTC (Commodity Futures Trading Commission), large speculators are holding the largest net short position in history. In 2018, the net short holdings peaked at nearly 680,000 contracts. At this time, large speculators are holding about 780,000 net short contracts. Will we get a repeat of what we have witnessed in the E-mini S&P 500 in which the historically overcrowded bearish position unwound itself, causing an unusual rally? We think so.

Chart

US Dollar weakness

All else being equal, a lower US dollar promotes higher US-denominated asset prices. The dollar index is on the brink of falling back into the pre-Ukraine-war trading range. A decline and weekly close below 100.00 would seal the deal for a weaker dollar; this would act as a tailwind for most assets, particularly Treasuries.

Chart

Inflation

The idea of runaway inflation ignited the original bond massacre of 2022. A year later, we know that inflation was peaking at precisely the time the markets were the most convinced the inflation cat was out of the bag and couldn’t be tamed. Inflation at 4% to 5% is still high compared to recent history, but in a world without aggressively loose monetary policy, 2% to 4% was considered acceptable. Perhaps we are simply falling back into a pre-Financial Crisis world of moderate inflation. With this in mind, it is fair to assume Treasuries are probably underpriced.

Chart

Conclusion

The stars are aligning for a contrarian trade in Treasuries. With the CPI on tap in the coming days, there is room for near-term volatility, but the inflation trend has been lower, and there are few signs of that trend changing. Shipping container pricing has subsided, commodity markets have displayed deflationary behavior, and the CPI has consistently declined. Perhaps the masses are positioned on the wrong side of the market at the wrong time.


Get Full Access To Our Premium Elliott Wave Analysis For 14 Days. Click here.

By using Wavetraders website, any services, products, and content contained here, you agree that use of our service is entirely at your own risk. You understand that there is a very high degree of risk involved in trading on the markets. We assume no responsibility or liability for your trading and investment results. The charts, and all articles published on www.wavetraders.com are provided for informational and educational purposes only!

By using the information and services of www.ew-forecast.com you assume full responsibility for any and all gains and losses, financial, emotional or otherwise, experienced, suffered or incurred by you.

Follow us on Telegram

Stay updated of all the news

Join Telegram

Editors’ Picks

EUR/USD drifts into Wednesday's top end after Fed Minutes, markets pivot to PMI wait

EUR/USD drifts into Wednesday's top end after Fed Minutes, markets pivot to PMI wait

EUR/USD drifted into the midrange before a late break into the high side on Wednesday after the US Federal Reserve (Fed) published its latest Minutes which showed policymakers continue to remain focused on downside risks.

EUR/USD News

GBP/USD trades with modest gains below the mid-1.2600s ahead of UK, US PMI data

GBP/USD trades with modest gains below the mid-1.2600s ahead of UK, US PMI data

The GBP/USD pair trades stronger below the mid-1.2600s during the early Asian section on Thursday. Investors will turn their attention to the UK and UK S&P Global Purchasing Managers Index (PMI) for February. 

GBP/USD News

USD/JPY Price Analysis: Hovers around the psychological support of 150.00 on Wednesday

USD/JPY Price Analysis: Hovers around the psychological support of 150.00 on Wednesday

USD/JPY could break below immediate support at the 150.00 psychological level. A break below a nine-day EMA at 149.81 could lead the pair to test the major support at 149.50. Technical indicators suggest a confirmation of the bullish trend for the pair.

USD/JPY News

Follow us on Telegram

Stay updated of all the news

Join Telegram

Editors’ Picks

AUD/USD prints slight gains post-FOMC minutes, mixed Aussie PMIs

AUD/USD prints slight gains post-FOMC minutes, mixed Aussie PMIs

The Australian Dollar posted minuscule gains on Wednesday against the US Dollar, after the release of the Federal Reserve’s January meeting minutes emphasized policymakers remain hesitant to begin to ease policy. Therefore, the pair exchanges hands at 0.6550, down by 0.02% as the Asian session begins.

AUD/USD News

EUR/USD drifts into Wednesday's top end after Fed Minutes, markets pivot to PMI wait

EUR/USD drifts into Wednesday's top end after Fed Minutes, markets pivot to PMI wait

EUR/USD drifted into the midrange before a late break into the high side on Wednesday after the US Federal Reserve (Fed) published its latest Minutes which showed policymakers continue to remain focused on downside risks.

EUR/USD News

Gold price hovers around the 50-day SMA as traders eye flash PMIs

Gold price hovers around the 50-day SMA as traders eye flash PMIs

Gold price is virtually unchanged after the US Federal Reserve released January’s meeting minutes, which reassured market participants that the Fed is in no rush to cut rates in the near term.  The XAU/USD trades within the $2020-30 range.

Gold News

Bitcoin price likely to fall but MicroStrategy’s $12 billion market cap makes it a possible S&P 500 candidate

Bitcoin price likely to fall but MicroStrategy’s $12 billion market cap makes it a possible S&P 500 candidate

Bitcoin price consolidation continues to stretch but steadily leans in favor of the downside. This is expected as markets tend to not wait that long. Meanwhile, Michael Saylor’s firm MicroStrategy is making headlines with a possible listing in the S&P 500.

Read more

Nvidia Stock Earnings: NVDA Q4 results trounce consensus

Nvidia Stock Earnings: NVDA Q4 results trounce consensus

Nvidia beat earnings consensus from Wall Street by a large margin on Wednesday, and the stock jumped more than 3% afterhours. Consensus had been $4.64 in adjusted EPS for the quarter ending in December, but Nvidia posted $5.16.

Read more

RECOMMENDED LESSONS

7 Ways to Avoid Forex Scams

The forex industry is recently seeing more and more scams. Here are 7 ways to avoid losing your money in such scams: Forex scams are becoming frequent. Michael Greenberg reports on luxurious expenses, including a submarine bought from the money taken from forex traders. Here’s another report of a forex fraud. So, how can we avoid falling in such forex scams?

What Are the 10 Fatal Mistakes Traders Make

Trading is exciting. Trading is hard. Trading is extremely hard. Some say that it takes more than 10,000 hours to master. Others believe that trading is the way to quick riches. They might be both wrong. What is important to know that no matter how experienced you are, mistakes will be part of the trading process.

Strategy

Money Management

Psychology