U.S. Treasury Bonds Now 2 Standard Deviations Cheaper than Stocks
Interest-Rates / US Bonds Apr 19, 2009 - 05:20 PM GMTBy: Levente_Mady
The bond market continues to chop around aimlessly. The market was stronger most of the week, but a 2 point sell-off on Friday destroyed all the gains and then some. The fundamental news turned considerably weaker – even in relation to expectations - but the stock market managed to show further gains for the 6th week in a row now. That generated further outflow from bonds to stocks. Based on the Fed model which compares the 10 year Treasury note to the dividend yield in the stock market, stocks made a close to 4 standard deviation move relative to bonds in a little over one month.
Stocks were 2 standard deviations cheap to bonds after the first week in March according to this flawed model and now bonds are very close to 2 standard deviations cheap to stocks as of this Friday’s close. For the moment it looks like the authorities have saved the world from imploding. As risk comes back in vogue, implied volatilities are imploding not just in the stock market – as measured by the well know VIX – but also in bonds and other markets as well. On the other hand, seeing 4 standard deviation moves in just over a month as described above tells me that perhaps markets are not quite as tame as they may appear at first glance.
As the economic calendar will be fairly light during the next week, some of the attention of the bond market will shift back to the central bank policy front. The Bank of Canada has its next policy meeting and rate announcement scheduled for Tuesday morning. With the present Bank of Canada rate at .50%, the motivation to lower rates further must be limited at best. There has also been chatter of a Canadian Quantitative Easing policy announcement on Tuesday. I see a limited impact of such a program as well. Our dollar could be the beneficiary if the Bank of Canada stays put on all fronts.
NOTEWORTHY: The economic data was mostly weak last week. The inflation reports were close to expectations, except for the headline Producer Price Index, which declined a massive 1.2% in March versus unchanged forecasts. The core component of PPI was in line with forecasts of no change as most of the headline number decline was caused by a drop in energy prices. Consumer Prices were much more stable as overall CPI declined 0.1% while the core component was up 0.2%. The first of the three most important data releases – the Retail Sales report – was disappointing as it fell 1.1% and it was substantially weaker than expectations of a 0.3% increase. The other most significant reports were also quite ugly. Capacity Utilization was first reported at 70.9% for February. Than figure was revised down to 70.3% and March’s level declined another point from there to 69.3%. Industrial Production declined 1.5% during the same period. With the collapse on the Capacity Utilization front the economy is opening an output gap that is quickly turning into an abyss.
Housing Start and Building Permits were again surprisingly weak as a 1 month rebound abruptly ended. Starts fell over 10% to 510k units while Permits collapsed to a new multiyear low of 513k units. Weekly Initial Jobless Claims dropped a sharp 53k to 610k, while Continued Benefits continue to skyrocket and are now over 6 million as they increased another 172k last week. Sentiment Surveys improved somewhat – both on the manufacturing and the consumer front – but remain in recessionary territory. The Canadian economic data is not setting the world on fire either. The Canadian inflation scene is a bit sticky. Overall inflation increased 0.2% in March while the annual figure now stands at 1.2%. The core component increased 0.3% as that annual figure is still stuck at 2.0%. Inflation is a lagging indicator, so we can expect further declines on this front. Next week’s schedule will be very light and it will be highlighted by the Durable Goods report as well as some further housing data. The market will be more focused on corporate reports as we hit the heavier part of earnings season.
INFLUENCES: Trader sentiment surveys remained stuck in neutral territory. Just like the bond market, this data series has been stuck in neutral and it is going sideways fast. In a perverse way, it has been an excellent predictor of the range-bound action in bonds. The Commitment of Traders reports showed that Commercial traders were net long 274k 10 year Treasury Note futures equivalents – a decrease of 50k from 2 weeks ago. This is very slightly supportive. Seasonal influences are negative. The technical picture is neutral as the market managed to stabilize since the third week in January. I expect the 124 to 130 trading range to persist for the Long Bond futures. Boring as it sounds, until we bust through either side of this range with some conviction, I am happy sitting in neutral and trading the range.
RATES: The US Long Bond future faded a half point to 125-11, while the yield on the US 10-year note increased 4 basis points to 2.95% during the past week. The Canadian 10 year yield jumped 10 bps to 3.02%. The US yield curve was steeper as the difference between the 2 year and 10 year Treasury yield increased 1 basis point to 199. The 200 level appears to be the magnet in this relationship.
BOTTOM LINE: Bond yields increased somewhat, while the yield curve was pretty much unchanged last week. The fundamental backdrop remains weak, which is supportive for bonds. Trader sentiment is neutral; Commitment of Traders positions are supportive and seasonal influences are negative. My bond market view remains neutral.
By Levente Mady
lmady@mfglobal.com
www.mfglobal.ca
The data and comments provided above are for information purposes only and must not be construed as an indication or guarantee of any kind of what the future performance of the concerned markets will be. While the information in this publication cannot be guaranteed, it was obtained from sources believed to be reliable. Futures and Forex trading involves a substantial risk of loss and is not suitable for all investors. Please carefully consider your financial condition prior to making any investments.
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© 2009 Levente Mady, All Rights Reserved
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