Weak Economic Data Sends Treasury Bond Prices Higher

By: Levente_Mady

The bond market was stronger last week as bonds rallied with help from disturbingly weak fundamental data and a fading equity market.  The final release of the first quarter GDP figure was revised down from the first cut of 3.5% to 3.0% on the second look and finally to 2.7% on last week’s figure.  Honestly it is beyond me how consensus can still be looking for 3-4% growth during the second half of 2010 in the US and Canada!  From my vantage point we will be lucky to print a positive number by the last quarter on either side of the border.  The front end of the economy is in shambles, the Fed is out of easing bullets as it is already at 0% and the newly found fiscal responsibility across the globe is certainly highly advisable but its short term impact will most likely be quite painful.

Much was made of the Chinese announcement of a crawling readjustment of their currency.  What a pile of dung!  First, the readjustment will be extremely limited and highly inconsequential.  Second, the timing was quite a no brainer the week before the G20 meeting.  Third, the market reaction was quite a chuckle as the expected positive equity/negative bond reaction turned out to be just the opposite.  And lastly that brings us to not being able to resist making our jaded comment of the week regarding the G20 meeting: when are these folks going to get real?  Don’t they have anything better to do than to waste billions of dollars on useless security?  I suppose Canada is not completely bankrupt yet like the PHIIGS, the UK, Japan, etc. so we can afford it…

The US Federal Reserve Bank surprised nobody with the results of its policy meeting.  It is quite clear that the Fed will continue to stick with its Zero Interest Rate Policy (or ZIRP for short).  Although some Central Banks such as the Bank of Canada and the Bank of New Zealand have recently hiked their short term benchmark rates, I think it is safe to say that the major central banks – the US Fed, the European Central Bank, the Bank of England and the Bank of Japan – plan to stay with their ultra low interest rate policies for the foreseeable future.  As per my expectations expressed in the commentary from last week, the Fed downgraded its outlook for the economy in the news release that followed its policy meeting.

NOTEWORTHY:  The economic calendar was unequivocally dismal last week.  There was further overwhelming evidence that the Housing Sector is a complete and utter disaster.  Existing Home Sales fell over 2% versus expectations of a 6% jump in May.  New Home Sales fell a mind boggling 30%+ to 300k.  This data series dates back to 1963 and even with the changes in demographics and all, this is the lowest print in the close to 50 year history of this metric.  Meanwhile mortgage applications continue to plunge even in the face of new lows in long term US mortgage rates.  Durable Goods Orders declined a less than expected 1.1%, but the more stable ex-Transport component actually increased 0.9%.  Weekly Initial Jobless Claims decreased from 476k to 457k last week and remain stuck on the wrong side of 450k.  The Michigan Consumer Confidence survey ticked up marginally to 76, but also remains stuck at recessionary type levels.  In Canada, the data was also quite disappointing.  Retail Sales fell 2% in April, reversing the bulk of the gains from the previous month.  This release is a bit dated, and we are expecting further weakness on this front.  Canadian CPI increased 0.3% in May, but the year over year figures declined from 1.2 to 1% on the headline and from 1.9 to 1.8% on the core front.  We might get a bit of a bump with the introduction of the HST next month on CPI, but the overall trend is likely to point down. 

Canadian 5 year bonds are back below 2.5% for the first time since February as rate hiking expectations in Canada start to fade.  This week’s economic schedule will be highlighted by Personal Income and Spending, the ISM Surveys, as well as the closely watched monthly Employment Report.

INFLUENCES:  Trader sentiment surveys we follow are slightly stronger.  On a scale of 0-10, the surveys  are a tad over 6.5, which is on the high side of neutral.  The Commitment of Traders report showed that Commercial traders were net long 225k 10 year Treasury Note futures equivalents – which is down 20k on the week.  This metric is neutral.  Seasonal influences are strongly positive next week with the usual month end/quarter end buying providing the fuel for the fire.  The technical picture is positive as the bond futures continue to hold up well.  The top end of the recent trading range at 125 is tested and likely to be violated next week.

RATES:  The US Long Bond future was up 1½ points to 125-11, while the yield on the US 10-year note decreased 12 basis points to 3.11% last week.  The Canadian 10 year yield decreased 12 basis points as well to 3.20%.  The Canada-US 10 year spread was unchanged.  The US 10 year yield is trading 9 bps lower than the Canadian 10 Year yield.  The US yield curve was 5 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 remains only very, very steep.

BOTTOM LINE:  Bond yields were lower across the board last week, while the yield curve tilted marginally flatter.  The fundamental backdrop looks increasingly supportive.  Trader sentiment is still positive this week; support provided by the Commitment of Traders data has evaporated while seasonal influences are strongly positive.  Based on this and the neutral technical set up, we are going to retain our neutral market position with a slight positive bias due to carry considerations.

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.

© 2010 Levente Mady, All Rights Reserved

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.