U.S. Treasury Bonds Break Below Support

By: Levente_Mady

The bond market gave up a major support level last week as the 10 Year Treasury Note moved decisively through 3%.  The stocks for bonds switch continued unabated, where it stops, nobody knows.  As the short end remains anchored, any back-up in long term rates causes the yield curve to steepen.  This is a good news – bad news story in the present environment.  It is excellent news for financials that can still afford to borrow short and lend long as they can earn a significant carry on that trade. 

It is bad news for the folks and organizations out there that need to renegotiate their 30 year mortgages or other long term debt.  And at a record 360% debt-to-GDP ratio, believe you me; there are more than a handful of those cowboys and cowgirls out there.
The US Federal Reserve Bank’s policy meeting was in line with expectations as far as rates (unchanged at 0-.25%) and the announcement to go with it promising to continue to keep rates ultra low.  Perhaps the slight surprise was that there was no further commentary on Quantitative Easing.  With the credit markets normalizing and stock market up 30+% in a little over a month, the Fed felt that liquidity is adequate at this point.  As a matter of fact, they seem to feel that allowing slightly higher yields may not be harmful at this juncture.  Now the Fed was completely asleep at the switch for years if not decades as the credit bubble kept rapidly expanding.  I have serious doubts that the Fedsters will be any more successful in navigating through what they perceive as a nascent recovery with any more success.  

NOTEWORTHY:  The economic calendar was a mixed bag last week.  Consumer Confidence is improving as the stock market recovers.  While both the Conference Board and the Michigan surveys are recovering from multi-year lows, the absolute levels are still in deep negative territory on both surveys.  The first cut at the Q1 real GDP was reported at -6.1%, a vast improvement over the -6.3% figure reported over the last quarter of 2008.  At this rate the US economy should be showing it first positive reading of +0.1% by the last quarter of 2016.  The authorities are undoubtedly correct in their assessment – things are improving!  In all fairness, that number was not as bad as it looked.  I like to check what the nominal figure is in order to eliminate the fluctuations that may be caused by quarterly adjustments to the inflation component.  Everyone and their uncle knows that inflation is not an issue with unemployment skyrocketing and Capacity Utilization at record lows, so I have some difficulty accepting that inflation rose 2.9% during the first quarter of 2009.  Adding that figure to the real GDP number, I come up with a decline of 3.2%, which looks a tad better than the -6.1% headline number. 

At the same time, China reported that the economy over there was “slowing down” to a +6.1% pace.  Funny enough, they are still expanding at what I would consider a decent clip, but their inflation component was not inflation at all, it was a significant deflation of -2.4%.  As a result, I would argue that the nominal figure of 3.7% GDP growth in China should at least be considered.  Weekly Initial Jobless Claims drifted 14k lower to 631k, while Continued Benefits continue to climb relentlessly.  More importantly, the consumer continues to retrench.  Personal Income declined 0.3% in March, while Consumer Spending was 0.2% lower during the same period.  The ISM Manufacturing Index improved a couple of points to 40.1.  A number below 50 forecasts a contraction in this metric.  Factory Orders declined close to 1% in March, while Auto Sales continued to be lousy in April.  In Canada, GDP declined 0.1% in February.  It will take us a few more months to catch up with the economic wizards abroad to figure out a first quarter figure.  This week’s schedule will be highlighted by the IMS Service Sector survey, Consumer Credit and the monthly data on the employment scene both in Canada and the US.

INFLUENCES:  Trader sentiment surveys moved lower, as the market broke key support.  While longer term this is supportive, in the short term it has more room to move before it becomes overdone.  The Commitment of Traders reports showed that Commercial traders were net long 334k 10 year Treasury Note futures equivalents – a decrease of 2k from last week.  This is slightly supportive.  It is also telling us that the smart money is not jumping ship as bonds remain under pressure.  Seasonal influences are negative for another week or two.  I would urge caution with the seasonals here as they tend to bottom out in May as the quarterly refunding wraps up – which is a tad early this year.  The technical picture is broken as the market cut through support like hot knife through butter at 124.  Short term this market could dip somewhat lower, but I maintain my positive bias and will be looking to buy dips into the 120 area.

RATES:  The US Long Bond future faded a couple of points to 122-05, while the yield on the US 10-year note increased 17 basis points to 3.15% during the past week.  The Canadian 10 year yield was 8 basis points higher at 3.10%.  The US yield curve was steeper as the difference between the 2 year and 10 year Treasury yield increased 18 basis points to 220.  The 200 level appears to be the magnet in this relationship for now.

BOTTOM LINE:  Bond yields increased again, while the yield curve was steeper last week.  The fundamental backdrop remains weak, which is supportive for bonds.  Trader sentiment is moving toward bearish territory; 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

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