U.S. Treasury Bonds, Stay Long and Earn the Carry!

By: Levente_Mady

The bond market did exactly what it was supposed to do last week: it pulled back to the break-out level at 120 and then it started moving higher again.  In spite of the massive bounce in stocks on Monday, the market remains quite nervous.  The long auction cycle included a record $16 Billion 30 year bonds on Thursday.  The market received the 3 year tranche very well, the 10 years were better than average and the long bond managed to drum up enough interest to keep key support at 120 intact.  While crude oil is leading commodities to the downside, gold continues to have a remarkable bid as it moved to new all time highs near 1250 on Friday.

It is time to spend a little time on the European scene.  First and foremost, $1 Trillion bailout packages just don’t seem to have the same effect as they used to. 

After the announcement of the latest “Shock and Awe” package from an apparently united European front, the Euro currency briefly bounced a little over 3 cents to 1.31 USD/Euro before heading south for the rest of the week.  It closed at 1.2387 on Friday, breaking to its lowest level in over 4 years.  Some of the weaker sovereign credits bounced substantially along with stocks, but as per the currency market reaction, the overall effect was less than awesome.  It should be duly noted that regardless of the market reaction, this bailout program was substantially different than the ones announced over the past couple of years.  While the Americans, Brits, etc. just kept throwing money indiscriminately at their problems in the hope that they would disappear (it certainly seems that they managed to succeed for the time being), the Euro package came with some strings attached.  As a matter of fact it came with quite a few strings attached. 

We have seen a number of announcements from the most troubled countries as to how they planned to get their fiscal house in order with specific spending cuts and tax increases over the past few days.  The consequences will be massive and hopefully two fold.  If these countries succeed in getting their deficits under control, the long term benefits will be enormous.  At the same time, the draconian measures that will be taken will have an immediate and substantial negative impact on their short term growth.  I certainly hope that they succeed because I certainly don’t believe that we can solve a global debt problem with further deficit spending.

In the agencies basket case column, after Freddie Mac lost a bundle the previous week, last week it was Fannie Mae’s turn to announce that they lost about $13.6 billion during the first Quarter and only asked for another $8.9 Billion from the Treasury to be able to repeat a similarly heart warming performance next quarter.

NOTEWORTHY:  The economic calendar offered no big surprises last week.   The US Trade Deficit increased $1Billion to $40.4 Billion mostly on higher costs for oil imports.  The US Treasury recorded its first ever monthly deficit during the month of April.  Just to make sure it was a good one, the number came in at -$83 Billion.  Weekly Initial Jobless Claims dropped marginally from 448k to 444k last week.  Retail Sales were roughly in line with expectations at a 0.4% increase, however the details in the report are hinting at some weakness ahead.  Industrial production increased a solid 0.8%, which was as expected, while Capacity Utilization was up from 73.1 to 73.7% but below forecasts of 73.9%.  The Michigan Consumer Sentiment Index increased a point to 73, but remains stuck at a low absolute level.  In Canada, the Trade Surplus dropped from $1.2 to 0.2 Billion in March.  This was lower than forecast.  The only surprise I see is that we still have a surplus.  This week’s economic schedule will be highlighted by Housing data, the inflation reports and Leading Indicators for April.

INFLUENCES:  Trader sentiment surveys we follow moved in the bullish direction again.  On a scale of 0-10, the surveys are at 6.0, which is moving in the right direction for the bulls but it is far from overbought to help the bears.  The Commitment of Traders report showed that Commercial traders were net long 394k 10 year Treasury Note futures equivalents – an decrease of 36k on the week.  This metric is still supportive.  Seasonal influences are diminishingly negative through May.  The technical picture is positive as the bond futures convincingly broke through the upside of the recent 114 -120 trading range two weeks ago and then it managed to test the break-out and successfully bounce from there.  Next resistance level is at 124 to 124.5 on the bond futures and nothing but daylight if we get through that.

RATES:  The US Long Bond future was nearly unchanged at 122-01, while the yield on the US 10-year note increased 2 basis points to 3.44% last week.  The Canadian 10 year yield decreased 6 basis points to 3.44%.  The Canada-US 10 year spread paused from moving in the US market’s favour.  The US 10 year yield is trading even with the Canadian 10 Year yield as the Treasury yield underperformed by 8 basis points relative to its Canadian counterpart.  The US yield curve was 6 basis points steeper with the difference between the 2 year and 10 year Treasury yield now at 266.

BOTTOM LINE:  Bond yields were pretty much unchanged through most maturities last week, while the yield curve tilted slightly steeper.  The fundamental backdrop remains supportive.  Trader sentiment is moving in the positive direction; support provided by the Commitment of Traders data is positive while seasonal influences are somewhat negative.  Based on this and the positive technical set up, we will be looking to buy into weakness during the rest of May.  Stay long and earn the carry!

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

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