Why are bonds so directionless?

The Technical Trader’s view:

WEEKLY CHART

The bund has been stuck in a close trading range since the beginning of December 2008.The precise placement of that trading range – around the pivot from the old high in 2005 only adds to the sense of confusion rather than consensus. Because pivots are naturally unstable places- tending to repel price action rather than attract it.

DAILY CHART

The short-term chart is good shows how little useful structure within the range can be discovered –emphasizing the lack of a spring board with which the market might break free from the range.

The Macro Trader’s view:

The Government Bond markets of the major economies have appeared to us to have been in denial for several months. Initially, when the credit crisis struck, before it became a full blown recession, we were bullish of bonds. As economic growth looked set to suffer we judged yields would tumble, and so they did for a while.

But as the crisis intensified and governments began committing tens of billions of Dollars to rescuing failing, yet systemically important banks, we became concerned at the fiscal health of several developed economies - the US and UK in particular.Both of these countries have seen their Governments pour extraordinary sums into theirfinancial systems and economies to ward off what has been judged to be the worst recession since the 1930’s. While it is right to allow government debt and borrowing to rise during a recession, is it right to trash a country’s fiscal stance in pursuit of saving banks whose management allowed themselves to fall victim to dubious investments of which they had little or no understanding?

In any event, right or wrong, the debt build-up that is now materializing could now well result in a bear market in bonds resulting from the UK needing to issue some £220.0B of Gilts this year alone as the Treasury struggles to finance the largest peacetime deficit on record .

While the Gilt market has sold off heavily in the last couple of days in reaction to the UKbudget, the US Treasury and Euro Bund markets seem to be resisting the downside a little better. With this unprecedented build-up of peace time debt, why aren’t investors taking fright and demanding higher yields as compensation for buying bonds?With the Global economy in recession, something that hasn’t occurred for quite some time, the usual bond purchasers are in difficulties themselves:

- China is coping with its own growth slowdown,

- So too is India,

- The Middle East oil exporter are experiencing a substantial decline in revenues from oil exports,And

- Private investors have taken a bath as the Hedge fund industry suffered a very difficult year.- It seems that what is keeping bonds away from a powerful bear trend is great uncertainty.

No one knows which is going to prove the greater of two evils:

- a weak economy, or - a deterioration in government finances.

What is clear to us is that if the answer is the weak economy, then government finances not just in the UK or US, but globally, are going to deteriorate further, and we would expect that to fuel a vicious bear market in bonds.

But while the jury is still out on what matters most: the economy or governmentborrowing, bonds are left teetering.

Mark Sturdy,John Lewis

Seven Days Ahead

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