U.S. Treasury Bond Yields Explode Higher, Opportunity to Buy 10 Year Bonds
Interest-Rates / US Bonds Nov 22, 2010 - 05:08 AM GMTBy: Levente_Mady
The bond market sold off a little more last week. Not only did the Treasury market sell off quite sharply over the past few months, but other sectors in the fixed income space got hit even harder. It appears that the market has been de-sensitized to all the sovereign problems of the basket case European countries. Financial markets just shrug nonchalantly when headlines of another Irish or Greek bail-out come across the tape. The sector that was perhaps even uglier than the European PIIGS over the past couple of weeks were the US municipal bonds. In our new cozy world, investors will need to start getting used to the idea that government bonds might not be as infallible or default proof as previously thought and priced. Meanwhile stocks remain close to 2 standard deviations expensive to bonds according to the Fed model I follow.
Part of the conversation last week continued about the reason for rising yields. Questions remain about the effectiveness of the unprecedented money printing programs of the US Federal Reserve. I suppose that with the extent of the sell-off in bonds we can safely say that QE2 has been less than a roaring success thus far. Although a number of experts seem to believe that the market is selling off because of inflationary concerns, I am of the opinion that it is something much more sinister than that: the sell-off in bonds is mainly driven by credit quality deterioration and it manifests itself in rising real yields. Core CPI has had the highest correlation with long term interest rates over the past 50+ years. Core CPI – as per the comments below – is at an all time low and still gravitating lower, while bond yields are moving the other way. Rising real interest rates are the worst enemy of this debt-stressed, fragile recovery. Y’all better get to praying that rates don’t rise any further, as they will crush both the public and private sector.
NOTEWORTHY: The economic calendar was mixed over the last week. The week started on a positive note with Retail Sales increasing a substantial 1.2% in October. The ex-Auto core component also increased, by a more moderate 0.4%. On the other side of the ledger, the news on the Fed’s Manufacturing Surveys was quite confusing as the New York State index collapsed 27 points to -11, while the Philadelphia area index jumped 21 points to 22. Inflation was very subdued in spite of the recent spike in a number of commodities including metals, energy, cotton and sugar. PPI increased a hefty 0.4% but the core measure declined 0.6%. Headline CPI was up 0.2% but the core component was flat for the 4th month in a row. Core CPI is sitting at an all time low of 0.6% Year-over-Year and it is still dropping. The Fed’s efforts to re-flate are certainly not showing up in this data series. Industrial Production was flat as a pancake last month while Capacity Utilization increased a tick to 74.8%.
Anything housing related was a disaster last week. The NAHB Housing Index remains stuck at a dismal 16 (out of 100) level. Mortgage Applications declined by 14% last week. No big surprise there with rates climbing relentlessly. Housing Starts collapsed from a downward revised 588k to 519k, while Building Permits held steady at a less than stellar 550k. Mortgage delinquencies increased 9% - no wonder Retail Sales increased, people were buying socks and all with all the money they saved by not paying their mortgages. Weekly Initial Jobless Claims held steady near 439k, which is a good sign for the labour market as this series is holding below the recent 450k equilibrium that this data series has been wrestling with for months now. Leading Economic Indicators increased by 0.5% on strong contributions from the steep yield curve as well as the strength in stocks. In Canada, Leading Indicators also increased but by a more tame 0.2%. This week’s economic schedule will include more regional Fed manufacturing surveys and reports on personal consumption, housing, durable goods orders, personal income and personal spending.
INFLUENCES: Trader sentiment surveys we follow stayed close to neutral last week. On a scale of 0-10, the surveys were stable near the 5.5 level, which is solidly neutral. The Commitment of Traders report showed that Commercial traders were net long 9k 10 year Treasury Note futures equivalents – which is a decrease of 10k over the past week. This metric is neutral. Seasonal influences are now positive for the rest of the year. The technical picture is cloudy as the bond futures decisively broke support at 130. Next support is at 125 or 3.05% on the 10 Year Note yield. I am a buyer of bonds once the 10 year note trades above 3%. We are expecting the bond market to find a bottom and at least bounce somewhat during the last part of November.
RATES: The US Long Bond future was down a little less than a point to 127-07, while the yield on the US 10-year note increased 8 basis points to 2.87% last week. The Canadian 10 year yield increased 12 basis points to 3.14%. The Canada-US 10 year spread moved in the US market’s favour. The US 10 year yield is trading 27 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 steeper, with the difference between the 2 year and 10 year Treasury yield out 8 bps to 237. Meanwhile the long end of the yield curve is moving the other way as the difference between 10s and longs was 13 ticks flatter to 137 bps.
BOTTOM LINE: Bond yields exploded higher last week, while the belly yield curve underperformed the wings. The fundamental backdrop looks solidly supportive. Trader sentiment remained neutral this past week; the Commitment of Traders data is less of a drag but still not helping, while seasonal influences are positive for the rest of the year. I am turning positive on the bond market and will be looking to buy 10 years north of 3%.
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.
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