U.S. Treasury Bond Market Keeps Chugging Along as Stocks, Gold and Commodities Remain Under Pressure

By: Levente_Mady

The bond market just keeps chugging along very convincingly here through the seasonally negative month of May.  The stock market and commodities remained under pressure as Gold has joined the sell-off.  Looking at the Fed’s stock vs. 10 Year Note Relative Value Model, it has drastically swung from bonds 2.5 standard deviations cheap in March to stocks 2.6 standard deviations cheap last Thursday.  Looks like some of the short term moves are a bit ahead of themselves at this point, but the message is fairly clear: the low hanging fruit has been picked as far as the risk-trade is concerned; the character of the market is rapidly changing.

It is time to spend a little more time on the European scene.  It is interesting to note that we are reading about all the problems that the PIIGS countries are experiencing on the runaway deficit front.  I seem to recall that the original Maastricht agreement for the European Union required member states to keep their budget deficits below the 3% of GDP threshold.  Those fiscally strict and overzealous Germans are undoubtedly the best of the European bunch.  At last check their deficit to GDP was sitting at a solid 6% - double of the limit allowed by the original treaty.  The rest of the non-PIIGS countries are obviously higher than that.  So listening to all this rhetoric from the European North certainly sounds like the pot calling the kettle black.  The Euro has been grossly oversold hitting 1.21 this week so it is due for a dead cat bounce before it heads back towards parity.

NOTEWORTHY:  The economic calendar was somewhat disappointing last week.  On the survey front, the New York Empire State Manufacturing index dropped 12 points like a stone to 19, but it remains in positive territory for now, while the Philly Fed Manufacturing Index was stable at 21 for May.  Foreigners continue to be in love with US securities – especially those evil Treasury bonds - as they bought a total of $140 Billion worth of American paper – including $108 Billion Treasury bonds and notes – in March.  The housing market continues to be a total mess.  While Housing Starts increased 5% to 672k as the housing tax credits expired at the end of April, the forward looking Building Permits tanked 12% to 606k and forecasting a major slowdown ahead.  Meanwhile, in spite of the lowest mortgage rates in a year and a half, mortgage applications for new purchases have fallen to their lowest levels in decades – again heavily influenced by the housing tax credit expiry.  Part of the reason why bonds continue to climb is the weaker than expected inflation data. 

Headline PPI and Core CPI both declined 0.1%, while headline CPI was flat.  The trend on these metrics remains down and in spite of all the stimulus out there, the risk of deflation continues to rise.  Weekly Initial Jobless Claims increased from 446k to 471k last week.  Leading Economic Indicators declined a disappointing 0.1% while the previous month’s figure was revised down.  In Canada, the strength continues.  CPI increased 0.3% both on the headline and core fronts – raising the year over year readings to 1.8 and 1.9% respectively.  Retail Sales (a bit stale as the latest report is for March) jumped a massive 2.1%.  Both of these data points along with a weaker Canadian Dollar are adding fuel to the fire for the Bank of Canada to move sooner than later on the rate hike front.  On the other hand just about everything that is happening in the markets (stocks, commodities imploding) and developments on the international economic front are screaming: Don’t do it!  This week’s economic schedule will be highlighted by more Housing data, Durable Goods, Consumer Confidence surveys, the second cut at the Q1 GDP data and updates on Personal Income and Spending.

INFLUENCES:  Trader sentiment surveys we follow moved in the bullish direction again.  On a scale of 0-10, the surveys are slightly over 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 – which is unchanged on the week.  This metric is supportive.  Seasonal influences are negative this week.  The technical picture is positive as the bond futures continue to break to new highs.  Next resistance level at 124 to 124.5 on the bond futures was penetrated successfully as the market closed above that level on Friday afternoon.  There is nothing but daylight on the upside as we got through that level.

RATES:  The US Long Bond future was up close to 3 points to 124-28, while the yield on the US 10-year note decreased 22 basis points to 3.22% last week.  The Canadian 10 year yield decreased 8 basis points to 3.36%.  The Canada-US 10 year spread resumed moving in the US market’s favour.  The US 10 year yield is trading 14 bps lower than the Canadian 10 Year yield as the Treasury yield outperformed by 14 basis points relative to its Canadian counterpart.  The US yield curve was 20 basis points flatter with the difference between the 2 year and 10 year Treasury yield now at 246.  The yield curve was ultra steep when 2s-10s were trading near 300.  Now it is only very, very steep.

BOTTOM LINE:  Bond yields were lower across the board last week, while the yield curve tilted flatter.  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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