I have noticed lately the increasing tendency of the media to acknowledge the risk of deflation. Compared to a few months ago when the tilt was clearly towards inflationism, this is a major change. While I think the deflation camp has a solid case, this new obsession offers a trading edge for the contrarian trader, even if only for a shorter period.
The deflation scenario is supported by falling interest rates and a slowdown in the economy. The media has been prompt in highlighting both. They also stress the need for more quantitative easing and the latest job report headline number gives them an excuse to march on this theme more confidently.
All this is reasonable thinking, but when it comes to markets what is reasonable does not necessarily make you money.. The bond prices have started rising when the inflation hysteria was flourishing. Now, as the majority became more aware of it, the deflation risk scenario may be already priced in. Surely, if the deflation scenario materializes the bond prices may go further up but at this moment a good shorting opportunity emerges.
The chart below presents the continuous contract for the 10-year US treasury note (chart courtesy of SaxoBank):
I have delimited by the blue horizontal lines the range in which the market traded at the beginning of 2009. Note that currently bond prices have almost reached the top of this range. I think this area is a good entry point for a short, probably on a rally after the Fed announcement on Tuesday. The red segment highlights a possible move to the bottom of the range.
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