U.S. Bond Market Holds Bottom

By: Levente_Mady

The bond market was a touch stronger last week as bonds managed to hold the bottom of the recent range again.  The fundamental news was a mixed bag, the FOMC offered no surprises so as a result we had a fairly uneventful week with a narrow trading range heading into the holiday season.  The yield curve is not budging from its record steep shape as the Fed made it clear again that they don’t plan to hike their benchmark overnight rate any time soon.

While the stock market feels like it has gone into early hibernation this year as it has been trading in a 4% range since the beginning of November, the surprise trade of the holiday season looks to be on the currency front.  The US Dollar index broke out of its recent doldrums with some conviction and could go further as the shorts get squeezed heading into year end.  Not much happening in bond land either.  The star of last year’s turn of the calendar trade – the US long bond, with a 25 point rally in December 2008 – does not seem to show any signs of life whatsoever at this point.  With a super steep yield curve, holders of long dated bonds get paid handsomely relative to what short term bonds and bills pay, but there are no guarantees that the yield curve can’t get any steeper.

As you all know the FOMC decided to leave short term rates at zero and announced that the good folks at the Fed had no plans to raise rates in the foreseeable future.  Besides all the usual Fed gobbledygook about how the economy is fine and inflation remains subdued, the talk was also focused on winding down the numerous asset purchase programs come next year.  Excess liquidity caused excessive valuations while the real economy was not invited to the party.  It will be a test to see how the recovery fares, as some of the liquidity is withdrawn from the market.  Meanwhile, our hero Ben Bernanke not only got re-nominated to be Fed chief for another 4 years, but he was also named Time magazine Man of the Year.  It just does not get much better than this!  On the other hand the contrarian in me would like to know how much upside this guy might have left?

NOTEWORTHY:  The economic calendar was a mixed bag last week.  On the inflation front, Producer Prices jumped sharply as PPI rose 1.8%, with the core PPI increasing 0.5, in November.  Both these figures were much higher than expected.  Consumer prices on the other hand were much better behaved.  CPI rose 0.4% - in line with expectations – while the core component was unchanged and below consensus.  The New York State Empire Manufacturing Index dropped sharply from +23 to a disappointing +2, which forecasts a flat manufacturing sector for that state.  Meanwhile, the Philly Fed’s manufacturing survey increased 3 points from 17 to 20.  Capacity Utilization and Industrial Production continue to recover as they both increased close to 1% last month. 

There is still a lot of slack on that front as Capacity sits at a relatively low 71.3%.  the Housing sector was also stronger as Housing Starts jumped from 527k to 575k – in line with expectations.  Weekly Initial Jobless Claims disappointed for the second week in a row as they increased slightly from 473k to 480k.  Leading Economic Indicators also increased 0.9% which was 0.2 above forecasts.  The Canadian inflation scene remains subdued but no longer negative according to the November CPI data.  Headline inflation is up 1.0% year over year in Canada while the core CPI dropped 0.3 to +1.5% also year over year.  This week’s economic schedule will be highlighted by the final revision to the Q3 GDP, additional Housing data, Consumer Confidence and the Durable Goods report.

INFLUENCES:  Trader sentiment surveys were unchanged last week.  On a scale of 1-10, the surveys I follow are just a shade below 6, which is still in neutral territory.  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 240k 10 year Treasury Note futures equivalents – an increase of 66k from last week.  This metric is neutral.  Seasonal influences are quite positive for the rest of the year.  The technical picture is neutral but fragile; I am still comfortable with a slight positive bias and a range of 118 to 125 to hold here.  We remain slightly long the bond market through some put positions on the Long Bond future and earning some cash through time decay.

RATES:  The US Long Bond future was up close to a ½ point to 118-08, while the yield on the US 10-year note decreased 1 basis point to 3.54% last week.  The Canadian 10 year yield was up 1 basis point to 3.40%.  The Canada-US 10 year spread narrowed 2 bps as the Canadian 10 Year yield was 14 basis points below the US 10 Year Treasury yield.  The US yield curve was unchanged with the difference between the 2 year and 10 year Treasury yield stuck at 274.

BOTTOM LINE:  Bond yields were stable in all maturities last week, while the yield curve remained at a record steep level.  The fundamental backdrop remains supportive for bonds.  Trader sentiment is neutral; support provided by the Commitment of Traders data has now faded but seasonal influences are positive.  While most of our indicators are in neutral territory, the fundamental backdrop and a strong seasonal influence support our slightly positive bias for the bond market.

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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