Sunday, June 05, 2005

The Next Top in the Bond and Note Futures

The bond and the 10 year note futures have been moving up strongly from their lows at 109 and 107-26 respectively in late March 2005. In this post I will try to estimate just how far this rally will carry.

I take a "top down" approach to forecasting. By this I mean that I first try to assess the direction of the market's long term trend (which generally lasts a year or two). Once I have done this then I look for evidence that indicates the market's position within the intermediate term trend which generally lasts two to six months. My analysis of the intermediate term trend is always dependent upon my conclusion about the direction of the long term trend.

My 2005 bond forecast predicted that the 10 year notes would rally for the first 8 months of 2005 and top out in August. I also predicted that the 2005 top would be below the high prices reached in June 2003 (bonds at 124-12 and notes at 121-03). So I think that the bull market which began in the bonds and notes from lows in May 2004 (bonds at 103 and notes at 107-26) is rapidly approaching its end.

When a market is in a long term sideways trend or trading range it is usually helpful to look at the divisions of the range to try to get estimates of where intermediate term trends which typically last 2 to 6 months) will stop.

The weekly chart of the T-bond futures above shows the divisions of the range from the 124-12 high in June 2003 to the 103-02 low in May 2004. This past Friday (not shown on the chart!) the bonds traded as high as 119-23, just above the 1/2 division point at 119-01. I think the market will now trade sideways for a week or two in a range of three points or so. After that I think the bonds will move up to the 7/8 division point at 121-23 where the moves up from the March 2005 and May 2004 lows will end.

Why do I think this rally has further to travel? First of all, my 2005 bond forecast did predict a top for late summer and so the rally should still have a couple of months to go on this basis. But I don't like to rely too heavily on such long term predictions when it comes to trading decisions. A better reason for expecting a move up to 121-23 lies with a box analysis of the weekly chart. Note that there is an obvious price box delimited by the drop from the February 2005 high at 117-12 to the March 2005 low at 109. This box is 8.375 points in height. Adding 8.375 points to the high at 117-12 we get 125-24 as the top of the next box. But my long term forecast says that the market should not go above the 2003 top at 124-12. Next I observe that the 1/2 point of the next price box is at 121-18, not far from the 7/8 division of the range at 121-23. So this is the target I choose for the end of the uptrend.

The analysis of the 10 year notes is similar. The weekly chart depicts the divisions of the range from the 2003 top at 121-03 to the 2004 low at 107-26. At this juncture I think the market will move up to either the 5/8 division at 116-03 or to the 3/4 division at 117-08. The February 2005 top was at 113-13 and the March 2005 low at 107-26, a range of 5.59 points. Using this as the box size the 1/2 point of the next box up is at 116-06 so I think that 116-03 is the more likely target for the notes over the next couple of months.

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