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Outlook: Bonds

Building a major peak

November 06, 2009

Chart of outlook for Australian bonds as at 6 Nov 2009

6 November 2009

The strong rally to an all-time high followed by an immediate strong drop back into the previous range provides a strong case for a major peak being made. The topping structure is far from complete and it will probably be a couple of years before serious downside action is seen. Until late 2012 prices should hold to a slow downward trend.

It was the inability to hold above the 2002 peak of 95.440 just after rallying from a multi-year cycle low that generated the bearish outlook. It will take a break of the 2008 low of 92.87 to confirm it. Prices will then be vulnerable to falling towards 89.00, the level of the 1994 low and the 1988 high.

The next stage down will be delayed for several months. The action since the June low of 94.135 is unfolding in a corrective fashion. The October drop that brought prices back to the June low completed the downward swing of this correction and the recent rise is the start of the next rally of the correction. Expect the rally to persist till March 2010 when the intermediate cycle is due to rollover, and challenge the 95.200/700 region.

From this point the vulnerability to an aggressive sell-off increases. Given that prices have to work through a trading range created over 10years, I am inclined to favour key boundaries not breaking in a hurry. Expect prices to break their multi-decade upward trendline but probably hold at the 1998 low of 92.87. A rally back to 94.200 by 2012 - to retest the broken trendline and the current range, in line with the multi-year cycle rolling over - will complete a retracement of the last decline, balance out the trading range to the right-hand side of the peak and clear the way for an aggressive decline.

An alternative path for this bearish outlook is that the correction develops a lot faster and peaks in December in the 94.850/95.00 region.

The risk to the bearish outlook will emerge in about a year’s time. If the next decline respects the upward trendline then prices can extend the existing multi-decade upward trend into a new high. The extent of the rally will be limited to just a few points above the 2009 high.

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