U.S. Treasury Bond Market Rally Hits Bernanke Brick Wall

By: Levente_Mady

The bond market continued to power ahead – until Thursday.  On Friday morning the All-mighty Ben Bernanke opened his mouth and the words of wisdom that were emitted have caused great joy and happiness for the risk trade and got the long bond futures to tank 2½ points on the day.  For a day it appears that Ben can walk on water, but I have to wonder how long before the deeply and increasingly disturbing reality will make this mirage disappear. 

The fact is that the Fed – and the Administration for that matter – is running out of policy bullets and the bullets that remain are of questionable quality in terms of their effectiveness.  So regardless of the support that All-mighty Ben has pledged on Friday, the fundamental backdrop remains precarious to put it mildly.  The economic news continues to come in mostly worse than dismal.  As a matter of fact, when the market rejoices that the Q2 GDP was ONLY revised from 2.4% to 1.6%, you know that the situation is less than ideal.  From the looks of it, economic growth in the second half will have a seriously difficult time exceeding the low bar of 1.6% set last quarter.  With consensus growth at 2.5%, further disappointments are highly likely to follow.

I am stunned that the officials at the Fed – led by Chairman Bernanke – are still willing to get up in front of the public and tell us with a straight face that they have everything under control and that they continue to expect the economy to snap back to their projected trend growth of 2.5-3.5% and should anything jeopardize that outlook, they believe they still possess the tools to rectify that situation.  After all what could possibly jeopardize their dreamy forecast?  The fact that in spite of record amounts of liquidity, lending is still declining – especially on the real estate front?  Could somebody tell them that at this point it is not about the price of credit – record low mortgage rates are not doing anything!  Or the fact that the consumer will have to pay – directly or indirectly - for all the government debt and liabilities that continue to pile up at a record pace?  Anyone who points at reduced consumer spending and the increase in the Saving Rate as our potential saviour needs to have their head thoroughly examined.  Someone please tell me what the impact of the exploding debt burden per capita will have on the Savings Rate.  Of course the pathetic state of the Labour market just does not matter either… 

NOTEWORTHY:  The economic calendar continues to massively disappoint.  The news on the housing front continues to be relentlessly worse than horrid.  Existing Home Sales dropped 27% (27%! That is just ridiculous!) in July to a 15 year low of 3.83 Million units.  Oh, and I almost forgot, the June data was revised down 2% (practically unchanged!) from 5.37 Million to 5.26 Million units.  New Home Sales only tanked 12% from a previous month’s data that was also revised down about 5%.  By the way, the New Home Sales figure of 276k units was an all time low for the close to 50 year history of this data series.  The Durable Goods Orders report was another massive disappointment.  Consensus was looking for a large transportation order led boost of 3+%.  What we got was a transport boosted growth of 0.3% with the ex-transport figure actually tanking 3.8% instead.  Weekly Initial Jobless Claims decreased a solid 31k from an upwardly revised 504k to 473k, which is still a far cry from the 450k equilibrium this data series was wrestling with just a few short weeks ago.  The Michigan Consumer Confidence Survey dropped a point to 68.9 – another data point below consensus and still at recessionary levels.  In Canada, Retail Sales managed to eke out a 0.1% gain in June after back to back (and downward revised) drops of 0.4 and 2.3% during the previous 2 months.  This week’s economic schedule will include the ISM surveys, data on Personal Income and Spending as well as the monthly Employment report.

INFLUENCES:  Trader sentiment surveys we follow moved ever so slightly higher last week.  On a scale of 0-10, the surveys are just under the 7.0 level, which is near overbought.  The Commitment of Traders report showed that Commercial traders were net SHORT 29k 10 year Treasury Note futures equivalents – which is a drop of 23k on the week.  This metric is negative.  Seasonal influences are positive heading into September.  The technical picture is positive as the bond futures continue to roar higher.  As per last week’s comment, we were looking to buy a 3-4$ dip from the 134 close last Friday.  The market rallied to 137 before we got the 3.5 point drop I was looking for.  Continued weak fundamentals and month end term extensions should provide support for the market next week, but I am still looking for a dip to the 130 level as a decent level to re-enter long positions.  In the mean time, option volatility has spiked, so selling vol makes some sense here as well.

RATES:  The US Long Bond future was down less than ½ points to 133-22, while the yield on the US 10-year note increased 3 basis points to 2.64% last week.  The Canadian 10 year yield decreased 6 basis points to 2.86%.  The Canada-US 10 year spread moved in the Canadian market’s favour.  The US 10 year yield is trading 22 bps lower than the Canadian 10 Year yield.  The Canadian 10 year is still 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 209.  The recent range is breaking lower as the curve is struggling to normalize.

BOTTOM LINE:  Bond yields were slightly higher across the board last week, while the yield curve tilted flatter.  The fundamental backdrop looks solidly supportive.  Trader sentiment was a snick more positive this week; the Commitment of Traders data is a drag while seasonal influences are positive.  The bond market broke to new high ground before pulling back 3.5$ from the top.  I will be buying on a further 2-3 point drop.

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

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