The bond market remained range bound last week. The New Year started off with a full slate of economic data, but the impact on the longer maturities was minimal. It looks like we have a stalemate between weak fundamentals that are supportive and supply concerns that present a headwind for the market for now. Meanwhile – in spite of the weak fundamentals – the risk trade continues to hum along. The market action on Friday was prime example that at this point one can throw the fundamentals out the window and the best strategy is to just buy anything you can get your dirty paws on.

There are a few other macro themes that I would like to discuss at the turn of the year. First and foremost, I would like to point out the increasing role that the government plays in most facets of the economy. Whether it is climate control, financial bail-outs, airline security, trade controls or a variety of other topics, I believe that increased government meddling is leading to decreased efficiency. Some estimates tell us that the government has some degree of control over 75% of the economic activity now. Not far now to 100% - the totalitarian state. I grew up in a communist country and had the pleasure of seeing first hand what a mess government incompetence can create and sincerely hope that something will transpire to stop this disturbing trend. For now however, buying bureaucrats such as Man of the Year Benny Bernanke appears to be the winning trade.

NOTEWORTHY: The economic calendar continues to be worse than appears. The only pleasant surprise last week was the continued uptick in the ISM Manufacturing survey, which increased 3 points to 55.9, indicating that this sector is expected to grow at an increasing pace. It is unfortunate that this sector represents only a small fraction of the economy, so the growth here will have a minimal impact. On the other hand, while the ISM Services survey also increased a point, it barely scraped back to 50.1, which is dead neutral. Auto sales ticked up in December to 11.2 million units which was slightly higher than expectations.

Weekly Initial Jobless Claims ticked up 1k from 433k to 434k. The Employment report was much more disappointing than it appeared.

Non-farm Payrolls fell 85k versus consensus expectations of a flat reading. At the expense of being redundant, I just wanted to mention that the US economy needs Payroll growth of 175k just to keep up with population growth, so an 85k decline in payrolls equates to a 260k drop in employment. The official Unemployment Rate that is determined based on the Household survey, remained unchanged at 10% even. While that in itself does not look too bad, the reason why it remained unchanged was because another 661k discouraged workers left the workforce and gave up on looking for a job. That number of course was counterbalanced by 589k – as in over half a million (!!!) – individuals losing their jobs.

The conclusion to be drawn from this report is that while larger corporations are mostly done with their staff cut-backs, they are not hiring new employees as of yet. In addition, smaller companies that do not participate in the Non-farm Payroll survey are far from finished with their cutbacks. The rest of the survey was also quite disappointing as the work week was unchanged at a very low 33.2 hours and hourly earnings increased a marginal 0.2% rate.

The last data point of the week was Consumer Credit. While most market watchers don’t pay much attention to this data series, I think it is one of the key metrics as to what is happening with the consumer. Consumer credit dropped a record $17.5 Billion. Revolving credit (i.e. credit card debt) imploded almost $14 Billion. In Canada, the Employment fell 2,600, which was significantly below expectations of a 20k increase. The Unemployment Rate was unchanged at 8.5%. This week’s economic schedule will be highlighted by the Trade Balance, Retail Sales, CPI, Capacity Utilization/Industrial Production as well as the latest Consumer Sentiment data from the University of Michigan.

INFLUENCES: Trader sentiment surveys became less bullish – more negative last week. On a scale of 0-10, the surveys I follow are at 4.5, which is 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 469k 10 year Treasury Note futures equivalents – an increase of 67k from last week. This metric is supportive. Seasonal influences are positive. The technical picture is poor as the Long Bond remains stuck at the low end of its trading range. We remain slightly long and will look to move to a neutral position on a bounce toward the 118 level.

RATES: The US Long Bond future was up 3 ticks to 115-15, while the yield on the US 10-year note decreased 3 basis points to 3.81% last week. The Canadian 10 year yield was down 1 basis point to 3.60%. The Canada-US 10 year spread narrowed 2 bps as the Canadian 10 Year yield was 21 basis points below the US 10 Year Treasury yield. The US yield curve was steeper with the difference between the 2 year and 10 year Treasury yield increasing 15 basis points to 285.

BOTTOM LINE: Bond yields decreased in the shorter maturities last week, causing the yield curve to tilt steeper. The fundamental backdrop remains supportive for bonds. Trader sentiment is neutral; support provided by the Commitment of Traders data is increasing again and 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.

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

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