The long bond futures moved up another couple of points as the fundamental backdrop looks to be increasingly dire. In spite of the bullish bias of equity options expiry week, stocks struggled mightily last week as the stocks to bonds investment flows gained momentum. We are back to the risk versus safe haven trade as the US Dollar and bonds benefitted from their perceived safe haven status.

One of the major headlines last week was the news of China selling $55 Billion worth of Treasury securities during the months of May and June. Surely that can’t be good for the bond market! As it turns out even with the massive Chinese selling, the US long bond futures gained 8½ points during those 2 months. The moral of the story is Chinese-Shminese, it is inflation expectations that drive bonds – Chinese transaction flow: it just doesn’t matter!

As far as I am concerned, the consumer remains the key. At 70% of the economy, the consumer will continue to have the overwhelming impact on economic activity. While government meddling (i.e. cash-for-clunkers or home buying tax credits) and other parts of the pie may have temporary impacts, the highest priority data I watch is all consumer related. It starts with job related info such as Weekly Jobless Claims and the Monthly Employment report and continues with spending related data such as Retail Sales, Consumer Credit, Housing data, Auto Sales and so on. Consumer Surveys are also important as they gauge the head space consumers find themselves in. I reckon that if the consumer does not have a job, he/she will not be spending as much as he would with a secure job. That is the main reason why I find the new trend to higher Weekly Initial Jobless claims extremely disturbing and negative for the economy. We hit 500k on this metric and if this trend remains intact going into September, it will have very negative implications across the board. At least that is the story the bond market seems to confirm with the 10 Year Treasury yield closing in on the 2.5% level.

NOTEWORTHY: The economic calendar continues to massively disappoint. On the manufacturing surveys front, the NY Fed Index was up marginally to 7 – signaling subdued growth – while the Philly Fed Survey dropped 12 points to -8 – expecting a contraction in the Pennsylvania region. The NAHB Housing Index dropped from 14 to 13, heading back to within a whisker of the all time lows registered a couple of years ago. Housing Starts were revised down from 549k to 537k for June and the July data was reported at 546k, below the already dismal expectations of 555k. PPI increased in line with forecasts of 0.2%, while the core component increased a higher than expected 0.3%. Bonds however completely disregarded the upside surprise as inflation does not seem to be an issue at this juncture. Industrial Production increased a stronger than expected 1% while Capacity Utilization popped 0.7% to 74.8%. Weekly Initial Jobless Claims increased from an upwardly revised 488k to an even 500k and look outright menacing at this juncture. The Conference Board’s Leading Economic Indicators were practically flat as the previous month’s downward revision offset the 0.1% print in July. In Canada, the main economic release was the HST affected CPI report. While the headline figure increased 0.6%, taking away the 0.7% effect of the Sales Tax increase, inflation actually declined last month. The tax adjusted core figure also dropped 0.1% leaving the year over year figure at a slowing 1.6%. This week’s economic schedule will include some more housing data, the Durable Goods Orders report as well as the second revision to the Q2 GDP data and the Michigan Consumer sentiment survey.

INFLUENCES: Trader sentiment surveys we follow moved ever so slightly lower last week. On a scale of 0-10, the surveys are just over the 6.5 level, which is near overbought. The Commitment of Traders report showed that Commercial traders were net SHORT 6k 10 year Treasury Note futures equivalents – which is unchanged on the week. This metric is negative. Seasonal influences are slightly positive for the rest of August. The technical picture is positive as the bond futures continue to roar higher. With the long bond yield well under 4% and the 10 year yield closing in on 2.5%, the market is now even more overbought, but short it at your own peril. We are looking to buy a 3-4$ dip here.

RATES: The US Long Bond future was up another 2 points to 134-00, while the yield on the US 10-year note decreased 7 basis points to 2.61% last week. The Canadian 10 year yield decreased 5 basis points to 2.93%. The Canada-US 10 year spread moved in the US market’s favour. The US 10 year yield is trading 32 bps lower than the Canadian 10 Year yield. The Canadian 10 year is trading cheap to the US here. The US yield curve moved flatter, with the difference between the 2 year and 10 year Treasury yield narrowing 3 bps to 212. The recent range is breaking lower as the curve is struggling to normalize.

BOTTOM LINE: Bond yields were lower across the board last week, while the yield curve tilted flatter. The fundamental backdrop looks solidly supportive. Trader sentiment was a snick less positive this week; support provided by the Commitment of Traders data has evaporated while seasonal influences are positive. The bond market broke to new high ground and with the renewed explicit support from the Fedsters; it is treacherous to fight the trend. My bias is neutral as the market is now well overbought.

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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