Seasonal's and Fundamentals Supportive of Treasury Bonds

By: Levente_Mady

The bond market sold off another four and a half points during the course of last week.  Market participants seem to be convinced that the worst is behind us as they were busy selling more bonds and buying whatever else they could get their dirty paws on.  This week there is another set of 3, 10 and 30 year Treasury auctions on deck.  That ought to hold the market back at the outset, but perhaps not after Thursday’s long bond auction.

The foremost question on my mind remains: where is sustainable growth going to come from?  While it is true that the employment report significantly exceeded expectations and a number of other indicators point to a slowing rate of contraction, they continue to point to a contraction never-the-less.  As long as consumers continue to lose their jobs and are forced to reduce their borrowings, economic growth will continue to be elusive and perhaps temporary at best.  For the first time since the Fed started easing in 2007, we had a significant rise in 2 Year Treasury yields.  In my opinion the Fed is staying put, so short term rates will remain low.

NOTEWORTHY:  The economic calendar was mixed last week.  Personal Income was better than expected with an increase of 0.5% in April but Personal Spending was not - showing a 0.1% decline during the same period.  In case you are wondering how on earth can income be increasing while over half a million jobs are lost; the answer is government stimulus.  Construction Spending increased 0.8%, while forecasts were looking for a 1.5% drop.  The ISM Manufacturing index jumped 3 points to 43, while the ISM Services remained pretty much unchanged at 44.  Both these forward looking indicators continue to point to a recessionary environment ahead.  Pending Home Sales jumped 6.7%.  Factory orders increased 0.7%, but the previous month’s data was revised down from -.9 to -1.9%.  Weekly Initial Jobless Claims remained stable near the 620k level, while Continued Benefits managed to drop (15k) for the first time in 20 weeks.  The monthly Employment report was a mixed bag. 

The Non-Farm Payroll Survey indicated that there were 345k jobs lost in May, but the previous months’ data was revised up by 80k+.  So net Payrolls declined 260k, which was approximately half the decline that was expected.  On the other hand, the Unemployment Rate jumped another half percent to 9.4%, which was worse than expectations of an increase to 9.2%.  Also, Hourly Earnings barely budged with a 0.1% increase, while the Average Workweek continues to drop to new lows.  Key data last week showed that in spite of the above mentioned sizeable increase in Personal Income, Consumer Credit continues to shrink rapidly and at an increasing pace.  Outstanding consumer credit declined by $15.7 billion, or at a -7.4% annual rate, in April, having contracted in six of the past seven months.  Expectations were for a much smaller drop of $7.0 billion.  

Additionally, the credit declines in both March and February were revised down by a total of $8.2 billion, making the last three months' percentage decline the most severe since June 1980.  Revolving credit fell at an 11.0% rate in April, its seventh straight monthly drop.  Non-revolving credit, mostly auto loans, fell 5.3%.  From a year ago, consumer credit is down 1.4%, the most since November 1981, led by a record 2.8% drop in revolving credit.  Consumer deleveraging will remain a major drag on consumption.  In Canada, the Q1 GDP declined a less than expected (!) 5.4%, but that was with a Price Index dropping a massive 6.5% as well.  In other words, Nominal GDP was off close to 12% in Canada last quarter. 

Nominal GDP in the US was only off 2.9% in comparison, as the Price Index in the US increased 2.8% during Q1.  Anyone who still thinks that Canada is likely to be a “safe haven” needs some seriously thorough medical examination.  The Canadian Employment report was quite disappointing, as Employment declined 42k, with 59k full time jobs up in smoke.  The Unemployment Rate jumped from 8 to 8.4%.  This week’s schedule will include the Trade Balance reports as well as Retail Sales and the Michigan Consumer Sentiment Survey in the US.

INFLUENCES:  Trader sentiment surveys moved further into bearish levels this week.  This is supportive from a contrarian perspective.  The Commitment of Traders reports showed that Commercial traders were net long 398k 10 year Treasury Note futures equivalents – an decrease of 109k from last week.  This is also positive.  Seasonal influences are positive.  The technical picture is still less than constructive as the market broke again to new lows for 2009.  There is a good chance that the 10 Year Note yield may get close to 4% as another large load of supply is set to hit the market.  I would like to reiterate my recommendation from last week: load up the 18 wheeler with bonds if we get to 4% in the 10 Year Treasury Note yield!

RATES:  The US Long Bond future declined 4.5 points to 113-07, while the yield on the US 10-year note increased 38 basis points to 3.84% during the past week.  The Canadian 10 year yield was 6 basis points higher at 3.44%.  At 40 basis points, the Canada-US 10 year spread starts to look enticing.  The US yield curve was stable as the difference between the 2 year and 10 year Treasury yield decreased 1 basis point to 254. 

BOTTOM LINE:  Bond yields jumped sharply across the curve, while the yield curve was little changed.  The fundamental backdrop remains weak, which is supportive for bonds.  Trader sentiment moved further into bearish territory – which is positive; Commitment of Traders positions are supportive and seasonal influences are bullish.  I recommend buying long bonds here.

By Levente Mady
lmady@mfglobal.com
www.mfglobal.ca

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