Tuesday, November 03, 2009

No Matter What the Fed Says, The 30 Year Looks To Be Screwed Into Year End
On October 24, this newsletter mapped out a case for a bearish resolution in the 30 year treasury that
could flush the 30 year to the 105-107 handles by year end. I am not saying there will be such a flush into
year end. However, it would be a disservice not to point out the possibility and to prepare for such a
scenario. And if there is going to be a downside resolution and increase in volatility, the first week of
November maybe starting it Here is why.

First, the Oct ISM report’s employment index not only expanded for the third consecutive month, it
accelerated.

Better yet, and more to the point, along with the acceleration in activity the ISM reports employment
index jumped from 46 to 53, indicating the first job expansion in the index since I can’t remember when.
This could mean that the Oct NFP report will also resume trending in a friendlier direction. With the jump
in the employment component, the Fed has been provided a convenient excuse to change the language and
remove “extended duration” with respect to the duration of its zero fed funds rate policy from its FOMC
statement tomorrow. Such a change in the language could be taken by bond vigilantes as a signal things
are indeed heating up under this fiscal/monetary stimulus, and so rates would move higher in anticipation
of a shift in monetary policy towards rate hikes.

Now, here is the catch-22 for the treasuries. What if there is not change in the language signaling a shift in
monetary policy towards tightening. Why, bond vigilantes can point to anecdotal evidence from the ISM
index and other economic metrics and say policy is way too loose and the risk of overheating is too great,
so rates would still back up. The treasuries would do the heavy lifting that the politically captured and
constitutionally challenged Fed is too afraid to do on its own.

So, either way you look at it, bond prices are at risk of a sharp plunge. The confluence of events this week
stemming from the eco-friendly ISM report on Monday, to the FOMC statement on Wednesday, to a
potential eco-friendly NFP report on Friday, could be the catalyst for sharply lower treasury prices into
year end based on some simple Elliott Wave models. These models suggest a fifth wave down has begun

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from the Oct 2 ISM report. If wave 5 is symmetrical in time and price to Wave 1 or 3, we’d expect the 30
year treasury to be trading down in the 105-107 range before year-end.

Note also that it was from Nov 3 2008 that the 30 year made a mad and insane dash from 11219 to 11423.
A year ago, the automakers were failing and the world was coming to an end for most of the mfg sector,

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and so what I am suggesting is that since things are showing improvement not just in the mfg sector, but
also the jobs component of the mfg sector, the 30 year can now do the exact polar opposite of what it did
from Nov 3 08 to Dec 18-31.

Now, if we step out to two larger timeframes and look at the 30 year monthly chart, we note that Oct 2009
was an outside down month. The Fed declared the recession over on Sept 23, and then high of Oct 2009
could not breach the June 2003 mfg recovery high. Go figure right? Any surprise that Oct 2009 was an
outside down month?

And if you look to where the 30 year wound up by May 2004 in response to the manufacturing recovery, it
landed in the 103 handle. Now, if we extrapolate further, and suggest that the correction off the Dec 2008
high might correlate to the correction off the April 1986 high in percentage terms, we’d expect the 30 year

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to trade down to the 103 handle by June 2010. That is the treasuries favorite window for setting highs and
lows.

So, if you can imagine the 30 year plunging to 103 by the end of the first half of 2010 on the back of
monetary and fiscal stimulus, then you might also be able to imagine money flows continuing into riskier
assets and anything but dollars.