The bond market traded mostly positive all week and followed the recent pattern of one ugly Friday alternating with one neutral Friday. This last one actually managed to eke out a small gain. The financial markets are shaping up to be a diverging tale of three themes. On the one hand we have the stock markets around the world relentlessly grinding to new highs, while on the other hand the bond market refuses to buckle as it continues to retain a strong safe haven bid. In the mean time, gold is also breaking out to the upside with some conviction. The yellow metal managed to achieve its highest weekly closing level ever at $1007 per ounce.

The question mark going forward will be: which sector is right? Will it be stocks and the risk trade? Or is it going to be the bond market and safe haven with a twist of deflation? Or will the gold bugs be triumphant with gold busting through the all time highs at 1034 on worries about money printing and inflation and all? Or could all three pull a Timex watch impression and take a licking and keep on ticking up? Personally, I prefer to put my money on bonds at this juncture. It has worked reasonably well as the Long Bond Futures are up about 10 points since the June lows and it pays the highest yield out of the above mentioned sectors. That is not to say that I would be out there pounding the table about shorting gold at this point in time and space…

Last week it was the usual second week of the month auction cycle again with 3, 10 and 30 year bonds for sale during the middle part of the week. Needless to say, the demand again was much stronger than average. By the time the 30 year auction got under way on Thursday, the market was up over a point from the previous night’s closing level. Our Asian friends continue to talk trash but they also continue to show up in force to buy the auctions. From the market action I suspect that they must have put in some fairly aggressive orders overnight to buy a decent chunk (like about 45%) of the 30 year auction.

The steady drum beat of financial institutions failing keeps rolling as another couple financial institutions failed last week. That takes the tally for 2009 to 91 and counting.

NOTEWORTHY: The economic calendar was fairly sedate. The most important economic data point last week was not very encouraging – a disaster would probably be a more appropriate description. Consumer Credit plunged a new worlds record $21.6 Billion in July and the June figure was revised down from -10 Billion to -15.5 Billion. It is definitely not what the authorities want to see at this point in the economic cycle with the massive fiscal and monetary stimulus that is forced into the system. The bottom line is that zero percent interest rates, cash for clunkers, no money down housing purchases, moratoriums on foreclosures and all are just not working as the real problem of just way to much debt is not addressed or even acknowledged by those who should know better. Weekly Initial Jobless Claims decreased 26k from 576k to 550k last week. The US Trade deficit jumped from $27.5 to 32 Billion in July as both imports and exports actually increased for a change. Consumer Sentiment ticked up another couple of points to a still dismal 70 (100 is neutral). In Canada, our Trade deficit hit another new multi-decade high of $1.4 Billion. The Canadian Dollar did not pay any attention whatsoever. To nobody’s surprise, the Bank of Canada left its overnight rate unchanged near zero. The Bank also repeated its displeasure with the annoyingly high level of the Canadian currency. Foreign exchange traders ignored the warning. This week’s economic schedule will be highlighted by inflation data in the form of PPI and CPI, Retail Sales, Capacity Utilization and Industrial Production along with some Housing data and a couple of manufacturing surveys. It will be a fairly busy week.

INFLUENCES: Trader sentiment surveys were unchanged last week. On a scale of 1-10, the surveys I follow are dead neutral at 5. I expect sentiment to be somewhat supportive going forward as there is plenty of room to rise before this metric becomes overdone. The Commitment of Traders reports showed that Commercial traders were net long 289k 10 year Treasury Note futures equivalents – a slight rise of 14k from last week. This metric is losing its positive influence. Seasonal influences are positive right through September. The technical picture is neutral as bonds are probing the top of the recent trading range again. A close above 121 on the Long bond future opens the door to test major resistance at 124. The new December contract traded up through 121 on Friday but it did not quite muster to close there. 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 was up 1½ points to 120-16, while the yield on the US 10-year note decreased 10 basis points to 3.34% last week. The Canadian 10 year yield was also lower, falling by 6 bps to 3.32%. The Canada-US 10 year spread narrowed to 2. The US yield curve was flatter as the difference between the 2 year and 10 year Treasury yield decreased 6 basis points to 244.

BOTTOM LINE: Bond yields were lower last week, while the yield curve became slightly flatter. The fundamental backdrop remains weak, which is supportive for bonds. Trader sentiment is neutral and slowly rising – which is somewhat positive; Commitment of Traders positions are neutral 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

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.

MF Global Canada Co. is a member of the Canadian Investor Protection Fund.

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