The bond market successfully chopped sideways last week. Inflation data on both sides of the border remains supportive in spite of the hawkish tone from the Bank of Canada meeting last week. The busy supply agenda continues to counterbalance the positive fundamentals as another record amount of supply (close to $130 Billion) is scheduled for auction during the next week. The continuing positive tone in commodities and equities still can’t seem to put any sustained pressure on rates to rise.

The economic calendar was light, but we had a policy meeting for the Bank of Canada scheduled last week and the Fed has its next Open Market Committee Meeting scheduled for next Wednesday. While the Bank of Canada did not raise its policy rate of 0.25% last week, it indicated in no uncertain terms that raising the rate will definitely be on the table at its next meeting on June 1 and the one after that on July 20. As per the comment below, with the Olympic effect wearing off we are already seeing the closely watched Canadian core CPI dip sharply from 2.1 to 1.7% and more importantly below the arbitrary 2% level that the Bank considers the inflationary threshold. With US core CPI fixing to fall through 1% and the Canadian Dollar rising close to 25% versus its US counterpart over the past 12 months, I am baffled as to where sustainable inflation is expected to materialize from in Canada.

Perhaps the Bank of Canada wants the Canadian Dollar to continue to march well beyond the current parity level to test the resilience of the export sector. Or perhaps the Bank just forgot that during the past decade more than once they jumped the gun on raising rates too soon only to turn around and ease again a meeting or two later. The 2 year Canada bond yield was over 2 times the US Treasury 2 year note yield half way through last week (Canadian 2 year at 2.05% versus US still below 1%). The Canadian front end is cheap! With the Canadian 10 year yield still 10 basis points or so below its US counterpart, buying 2 year Canada bonds to sell the 2 year US Note is a low risk – high reward pair trade in my opinion.

NOTEWORTHY: The economic calendar was light. The Conference Board Leading Economic Indicators powered ahead again in March with a massive 1.4% increase. On the other hand the less watched Coincident to Lagging Indicators metric that fewer analysts watch (perhaps that is why it has a better track record in predicting economic activity) is running out of steam and has been stuck in the mud for a few months now. Weekly Initial Jobless Claims dropped from 480k to 456k last week. Headline PPI jumped 0.7%, while the core component was much more sedate with a 0.1% on consensus increase. The housing data was strong but deceptive last week. Existing Home Sales increased 7% to 5.35 million annualized units in March, while New Home Sales jumped 27% to 411k annualized units during the same period. There were 2 factors at work; first, there was a bounce from the negative weather impact in February and second, first time buyers increased their participation due to the tax discount that is set to expire again this month. I also mentioned that the numbers were deceptive as seasonal adjustments and some suspect figures in New Home Sales in the South Region have substantially impacted the data. Durable Goods Orders were similar to a number of recent economic news, some good and some bad.

The good part was the ex-transport component – which grew 2.8% last month, the bad part was the headline number - which declined 1.3% during the same period. In Canada, the dated February Retail Sales increased 0.5% - which was less than forecast. On the inflation front, Canadian CPI dropped 0.1% on the headline and declined 0.2% on the core component in March – both well below forecasts. The year over year CPI now stands at 1.4%. This week’s economic schedule will be highlighted by consumer confidence surveys and the preliminary GDP report for the first Quarter of 2010.

INFLUENCES: Trader sentiment surveys ticked up marginally last week. On a scale of 0-10, the surveys I follow are slightly above 5.0, which is not much help. The Commitment of Traders report showed that Commercial traders were net long 544k 10 year Treasury Note futures equivalents – a decrease of 91k on the week. This metric is still strongly supportive. Seasonal influences are negative through the end of May. The technical picture remains neutral as the Long Bond continues to aimlessly chop sideways. The 10 year Treasury Note yield has been stuck in a narrow trading range between 3.5-4.0% since December. Until we see a solid breakout, the market is telling us that it wants to drift sideways. We are sticking with our neutral view until there is compelling evidence to change.

RATES: The US Long Bond future was essentially unchanged at 116-29, while the yield on the US 10-year note increased 4 basis points to 3.81% last week. The Canadian 10 year yield increased 2 basis points to 3.70%. The Canada-US 10 year spread moved out 2 bps as the Canadian 10 Year yield was 11 basis points below the US 10 Year Treasury yield after coming close to even during the week. The US yield curve was 7 basis points flatter with the difference between the 2 year and 10 year Treasury yield now at 274.

BOTTOM LINE: Bond yields were marginally higher across most maturities last week, while the yield curve tilted slightly flatter. The fundamental backdrop remains supportive. Trader sentiment is neutral; support provided by the Commitment of Traders data is hugely positive while seasonal influences are negative. Based on this info, we are stuck in neutral mode. Stay long and earn the carry!

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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