The Monday Edition- Fixed Income Strategy For This Week & Speculative Trade (ENCY)

I've finally got some spare time, so thought I'd share my thoughts on one wild week we're going to have.

• The price action in the US 10-year Treasury yields last week was extremely bearish as the bull channel in place since the 1990s was broken, when 10-year yields passed 5.03%, compromising the lower highs (as evident in the chart below). The relevance of this bull channel should not be underestimated as it reflects a period when the Fed was able to lower inflationary expectations in the US economy.

• The failure of the 10s to find sufficient buying interest to maintain the longer term trending pattern is indicative that longer term inflation expectations may no longer be contained in subsequent cycles if the data continue to firm up, the core inflation data don't come down fast enough or the unemployment rate fails to hook up.
  
  
• How do we trade it? (please refer to the chart) First, if I ignore the break in the longer term trend, I would look for resistance at the brown line 5.20-.25% near term range in the 10s, and the next logical resistance would be at 5.5% the resistance in 2002 and 1999. With the break of the longer term bull channel, price action may not be confined in the trading range and risk remains to further market deterioration in coming months.

• This week the markets have to digest vital data such as the CPI and Beige book. With a solid gain in retail sales ending marginal support to the view that a housing recession has failed to curb American consumers spending. That’s a message that the Beige Book should send as well.
  
  
• Ben Bernanke’s latest comments coincide exactly with the week ahead’s most important release, CPI. Note that core CPI has been limited to 0.2% or less in 9/10 preceding months, and the bond market would take obvious comfort in a benign 0.1% core reading.
  
  
• A lot of damage has already been done, but the market looks defensive at this juncture. Should US economic activity not slow significantly, the odds are high that the shorter end of the curve will begin to price in Fed tightening and that both short and longer term yields will head higher (scenario 1, as depicted in the chart).