Treasury Bond Holders Receive a Pasting, Though Seasonal Influences Remain Bullish

By: Levente_Mady

The bond market got pasted last week.  While the trend in bonds has been sideways, it is noticeable that there has been a fairly predictable cycle within the course of each month related to the Treasury auction calendar.  The first week of the month has the announcement for the long auction cycle consisting of 3-10-30 year auctions to be conducted during the second week. 

Dealers sell the market fairly aggressively heading into the auctions - as a result the first week and a half of the month has a negative bias.  Once the supply is out of the way – regardless of how it is received – the market tends to recover for the rest of the second week and a good part of the third week.  Depending on how the days of the week work out, during the third or fourth week another announcement is made for the short auction cycle consisting of 2-5-7 year auctions to be conducted during the last full week of the month.  The market trends down from around the auction announcements into the second or third leg of the auction cycle and then it proceeds to rally into month end.  The waves of course are influenced by other data as well, but the auction schedule has definitely had an visible impact on trading.

Meanwhile in the real world, we had 2 more banks shut down by the authorities this weekend.  That takes the count up to 71 and counting for this year.  Next week we have the next meeting of the US Federal Reserve Bank’s policy setting committee.  I wonder if those guys are counting these failures and if the plan to add the Federal Depository Insurance Corporation (the good folks that are in charge of bailing out the failed banks and guaranteeing the depositors’ funds) to the list of basket cases that they need to bail out in turn. 

Last week the European Central Bank held their rates and policies stable while the Bank of England surprised the experts by expanding their asset purchasing program by another cool GBP50 Billion.  They could not surprise by lowering rates again as they – along with the Fed – are already pretty much at 0%.  I was reading some commentary about some experts looking for the Fed to pare back their asset purchases supporting the credit markets as the economy appears to have stabilized.  I expect this would be out of character with the Bernanke Fed, but if it does happen, it will likely have a negative short term impact on the bond market.  I am sure they will talk up green shoots ad nauseum.

NOTEWORTHY:  The economic calendar was another mixed bag last week.  The ISM Purchasing Managers Surveys were certainly mixed: the less significant Manufacturing series was higher and better than expected at 49, while the more significant Services series declined to a lower than expected 46.  I think it is proper to note that they both continue to point to ongoing contraction in their respective sectors of the economy.  Weekly Initial Jobless Claims fell from 588k to 550k last week.  The closely watched monthly employment report looked rosy on first blush, but the internals were still quite rotten.  First of all, the economy lost another 250k jobs in July according to the official report.

That means there are another 400k+ people that were out of work after July considering the natural rate of growth for employment age residents in the US.  The Unemployment Rate actually declined from 9.5 to 9.4%, not because the government or the economy is creating jobs, but because close to half a million discouraged people quit looking for a job last month.  Not only are consumers under massive pressure on the labour front, but Consumer Credit continues to freefall as well.  This data series declined another $10.5 Billion in June and it is now declining at over 2% per year in absolute terms – a rate not seen since World War II.  In Canada, the employment scene was weaker than weak expectations again in July.  Employment declined 45k versus a -30k forecast.  The two reasons the official Unemployment Rate did not rise from the previous month’s 8.6% level was because droves of discouraged workers are leaving the workforce and another 35k Canadians chose to become self-employed instead of un-employed.  This week’s schedule will include the Trade Balance, Retail Sales, inflation data as well as Industrial Production and Capacity Utilization.

INFLUENCES:  Trader sentiment surveys were more bearish for the second week running.  I expect sentiment to be somewhat supportive going forward as there is plenty of room before this metric becomes overdone.  The Commitment of Traders reports showed that Commercial traders were net long 430k 10 year Treasury Note futures equivalents – essentially unchanged from last week.  This is positive.  Seasonal influences are negative for a couple of days, before turning strong positive after mid-month.  The technical picture is neutral as bonds remain in a trading range.  I expect that we should get some follow through to higher prices in the long bond during the weeks ahead.

RATES:  The US Long Bond future cratered over 3½ points to 115-10, while the yield on the US 10-year note jumped 38 basis points to 3.86% last week.  The Canadian 10 year yield was 15 basis points higher at 3.61%.  The Canada-US 10 year spread increased 23 basis points to 25.  The US yield curve was steeper as the difference between the 2 year and 10 year Treasury yield increased 20 basis points to 256. 

BOTTOM LINE:  Bond yields increased sharply last week, while the yield curve became steeper.  The fundamental backdrop remains weak, which is supportive for bonds.  Trader sentiment turned is slightly bearish – which is not much help; Commitment of Traders positions are supportive and seasonal influences are bullish.  I recommend keeping the long bonds that were purchased back in June.

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

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