The yield curve is a depiction of the difference between short-term and long-term government interest rates, and you can trade these differentials with futures contracts. Near the shorter end of the curve, a daily chart of five-year Treasury note futures shows the market hit a double top near 115, and then recently broke out above that level. This chart is looking very bullish.

Right now, we are living through one of the greatest financial stresses of our time. The number one cause of any financial stress is lack of liquidity, as borrowed money is essential for the entire world to operate. At the first sign of panic, institutions hold onto reserves and don’t want to lend them out, and individuals hang onto their money.

The Federal government has stepped in to improve liquidity, and whether you agree with the financial bailout and other measures or not, it’s irrelevant. What’s done is done. The government can’t carry this load indefinitely, but it will try to avoid a disaster, a depression. One thing the government can do is to steepen the yield curve by lowering interest rates at the far short end. A steep yield curve means longer-term rates are higher and rising faster than shorter-term rates. The longer you lend your money, the higher rate you’ll receive. A steep yield curve makes the bankers’ jobs simple—it’s not so hard for them to figure out how to make money. Some even say it “makes a genius out of any fool at a bank.” 

The steeper yield curve will ultimately bring liquidity back and will eventually save the day. It entices people to save and lock up money for more extended periods. Treasury futures prices trade inversely to yields, so as longer-term interest rates are going up, the price of a 30-year bond will drop, and while shorter-term rates are going down, the price of the five-year notes are going up. As a trader, I recommend playing this steeping trend by legging into a spread. Keep in mind, one five-year note contact is not equivalent to one 30-year bond contract, so you would want to trade five note contracts to two bond contracts. I would currently recommend buying dips in the five-year note futures and selling rallies in the 30-year bond futures on a 2.5 to 1 ratio.

U.S. Dollar

The U.S. dollar has been an interesting play. A daily chart of the ICE U.S. Dollar Index futures contract (which represents the dollar against a basket of six global currencies) showed classic signs of bottoming from May through July 2008. In early August, great amounts of selling came in when the dollar rose above 73, but the market refused to break out, and the lows from March held. Relentless selling in a market that doesn’t break is a sign that a rally may be coming. I recommend buying dips when you see this type of setup. The government was printing money, but not so much to stimulate the economy, in my opinion, but rather to replace lost wealth. Because of the lost wealth factor, the situation was a bit different from other similar currency moves in the past. The game was different.  

 We witnessed the same scenario in the 1990s in Japan, after their economic bubble burst. The government brought interest rates to zero, the yen exploded and all assets lost value. Look at what’s going on today…does this sound familiar?

The financial sector has been breaking down around the world, and the world has been most comfortable buying U.S. dollars. That’s what they have been flocking to since late summer. I am not sure how much of the dollar’s rally is legitimate based on classic fundamental factors, or has just been a flight-to-quality play.

In the past two or three weeks, we have started to see signs of a potential reversal of the dollar’s bullish trend, but I’m not sure whether it’s consolidation within the larger trend, or a real change. I do think the dollar could have a decent pullback, even to 80, but until proven otherwise, I would stay with the longer-term trend and stay long the dollar, and short commodities. We are in the midst of some major corrections, but overall, I think the trends of the past few months are still intact.

The markets are extremely volatile, and I have found myself changing my thought process from day to day too many times. What has helped me is to focus on the trend, study the charts, and pull all emotion from the markets. Remember, trade what you see, not what you think. Trends don’t typically reverse on a dime—assume they are alive and intact until proven wrong. Don’t try to pick a top or assume a top is in, because markets can extend farther than most people can imagine possible.

Mike Hinman is a Senior Market Strategist with Lind Plus, Lind-Waldock’s broker-assisted trading division. He can be reached at 866-471-2048 or via email at mhinman@lind-waldock.com.

Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.

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