Those in search of trading opportunities might soon find what they’re looking for in an unlikely spot: the U.S. government bond market. Following the dramatic drop in yields that occurred through the middle portion of 2011, Treasuries have been mired in a tight trading range for four months. If you have turned your attention elsewhere, it’s time to start watching the bond market again — both for the trades available in leveraged ETFs, as well as for its implications for the stock market.

First, the hard numbers. Below are the beginning and ending yields Nov. 1, 2011, through Friday, March 2, as well as the upper and lower end of the trading range for this period:

Click to Enlarge The one-year chart of the 10-year yield provides an idea of how tight the range has been in the past four months:

Factors that Could Drive Bond Market Performance

The million-dollar question, of course, is which way yields break from here. There are two factors that indicate that this range eventually will resolve itself with yields moving to the upside.

Click to Enlarge First, the 200-day moving averages are quickly collapsing down on the current level of yields (as can be seen in the chart above). Although it’s somewhat surprising that the 200-day would be a factor for such a large, global market as U.S. Treasuries, breaks through this key moving average actually have proven very sustainable in recent years, as seen in this chart of the 10-year note:

Click to Enlarge Second, the 30-year Treasury yield looks to be on track for a move to the upside. The 30-year closed Friday at 3.114%, near the upper end of the range at 3.19%. This level has been reached twice during the four months that the range has been in effect, on Feb. 9 and Feb. 21. Also, the 30-year bond has been in a persistent uptrend — with a series of lower highs — for nearly three months now.

Also, note the broad, rounding shape to the 20- and 50-day moving averages and the potential for a golden cross (the 50-day moving average rising above the 200-day) within the next two to three months. In this case, of course, “golden” for yields would mean the opposite for prices.

Click to Enlarge A cleaner way to monitor the bond market might be the iShares Trust Barclays 20+ Year Treasury Bond ETF (NYSE:TLT), which closed Friday at $117.15, 1.9% above its support at $115 and 7.2% above its 200-day MA. TLT is invested entirely in long-term Treasuries with maturities between 2036 and 2042. A move in the TLT below $115 would indicate a growing likelihood that the government bond market is about to hit some turbulence.

What It Means for Equities

Click to Enlarge If yields do break to the upside, it likely would be a positive sign for stocks. Rising Treasury yields typically have been accompanied by stronger equity prices in the past five years, as can be seen in this chart. It’s reasonable to expect that this correlation trend would continue, since higher yields would reflect an improving outlook for growth with no accompanying risk the Fed will begin to tighten policy.

There’s certainly a chance that the correlation might not be as strong this time given how far equities have rallied already, but a meaningful uptick in yields — which would signal another nail in the coffin of the fear trade — would represent an important pillar of support for stocks.

Where Could a Rising Yield Trade to Lose Money?

The key factors that would favor a renewed move in yields to the downside are a resurgence of the European debt crisis (which seems increasingly unlikely at this point), a surprise on the geopolitical front, or a series of weaker-than-expected economic data. Although the popular view seems to be that the economy is now out of the woods, the Economic Cycle Research Institute has an opposing view that’s worth a look for any investor who views improving growth as a sure thing.

The most prudent course right now is therefore to watch and wait before making a move. Not only is there the ongoing risk of adverse news events, but the tight, longstanding nature of this range increases the risk that Treasuries could remain a dead-money trade indefinitely.

On balance, however, it seems that the most likely direction of Treasury yields is upward. When the time comes to capitalize on this shift, investors have the option of either shorting or buying puts on one of the long ETFs, such as TLT, or purchasing one of the 14 ETFs devoted to betting against the Treasury market. The leveraged options include: PowerShares DB 3x Short 25+ Year Treasury Bond ETN (NYSE:SBND), ProShares UltraShort 7-10 Year Treasury Bond ETF (NYSE:PST), JPMorgan Double Short US 10 Year Treasury Futures ETN (NYSE:DSXJ) or JPMorgan Double Short US Long Bond Treasury Futures ETN (NYSE:DSTJ).

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.