Bond futures rallied after last Friday’s jobs report because the data was considered “soft.” Non-farm payrolls grew by 120,000, which really isn’t all that bad, but the markets trade off expectations and were looking for an even bigger number.

In any case, the thinking was that if the number indicated a softening economy, the Federal Reserve would be less likely to raise interest rates again. Lower rates equal higher bond prices and, therefore, a rally in the bond futures.

The Fed can control short-term interest rates, but it has much less control over long-term rates. Long-term rates are set by the market, based in great measure on expectations of inflation and to an extent--because so many US bonds are held by foreigners--on expectations of the future value of the dollar.

I believe inflation is heating up; commodity inflation isn’t going away due to factors I’ve previously discussed, including growth in China and India and the global population explosion. I also believe the dollar will weaken over time--until the US can start to reduce its budget deficit and trade imbalance. And it doesn’t look like either of these things is going to happen any time soon.

Let me ask you this question: At what interest rate would you feel confident tying up your money for 30 years? Would you feel comfortable buying a US dollar-denominated 30-year Treasury bond at just above 5 percent? I’d rather park my money for a shorter term; right now, you can get that 5 percent return from a six-month Treasury bill with very little risk. I wouldn’t be comfortable tying up my retirement money in a 30-year bond at 5 percent because if inflation heats up and/or the US dollar depreciates in that time, the value of my bond could easily fall much more than that.

The US government bond is now yielding just more than 5 percent--5.17 percent to be exact--after Friday’s rally. The bond futures rallied above their 50-day moving average (represented by the purple line on the chart below), but then failed to close above it. Take a look at the chart of the 30-year bond futures, and you’ll see a market in a long-term downtrend. True, it's had a one-week rally, but this looks to me to be merely a correction within the overall trend. In other words, the bond market has shaken out the weaker short sellers, and therein lies an opportunity to profit from higher interest rates.

September Bond Futures



Source: Commodity.com

If long-term rates begin to head up again, the bond futures will break and they could break hard over time. Take a look at the monthly chart of the 30-year Treasury bond. It appears that a long-term uptrend line has been broken and bond futures at greater than par don’t look that far off, at least when you view this market from this perspective.

Monthly 30-Year Treasury Bonds



Source: Commodity.com

With bonds currently trading close to 107, a break to 100 would equate to approximately a $7,000 profit (to a short seller) for each contract shorted. I’d risk no more than a point and a half on a short sale, a risk of approximately $1,500 per contract. If the bond futures rally to the mid-108 area again, my premise is wrong and you should exit all short sales. However, if you agree with my premise (i.e., long-term rates have additional room to move higher), then the timing appears right to go short and profit from higher interest rates.

George Kleinman is editor of Commodities Trends.

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