U.S. Treasury Bonds Reach Extreme Overbought State

By: Levente_Mady

The bond market not only held the breakout levels from a couple of weeks ago, but continued to power ahead to the lowest yields seen on long term Treasury Bonds in half a century. The US administration, the Treasury and the Federal Reserve along with authorities world wide have been desperately trying all sorts of new programs to foster the flow of credit. Thus far these programs have not seemed to work. It feels like the authorities are just throwing money, programs, bailouts at a wall and hope that something will stick.

The credit markets remain in turmoil as spreads continue to drift wider. The stock market had a bit of a bounce, but the volatility is not going anywhere. Commodities appear to be hopeless as most energy, metals and agriculturals are down well over 50% from the high water marks set earlier this year. Half way through the summer all the talking heads were forecasting 200$ oil and discussing “political premiums” and terminal depletion of oil reserves.

None of that seems to matter as oil is now fixing to crash through 40$ per barrel – down over 70% in 5 months. The relief that is provided by gas prices falling from over 4$ a gallon to well below 2$ does not seem to make any difference as literally millions are losing their jobs. One item that has worked – especially during the past month – is the rally in the Treasury Bill and Bond markets. Last week Professor Bernanke – the expert on the monetary policy mistakes that were made during the Great Depression of the 1930s – declared that the Fed was prepared to conduct outright purchases of Treasury Bonds in order to encourage lower yields on these securities. It was like adding fuel to the fire: bonds loved it and moved to new highs.

On the Central Bank activity front, December started off with a flurry of aggressive easing moves: the European CB lowered it's rate by .75 to 2.50%, the Bank of England slashed it's benchmark by 1 to 2.0%, Sweden axed 1.75 off it's key rate to 2.0%, the Royal Bank of Australia joined the party decreasing by 1.0 to 4.25%, while the Royal Bank of New Zealand cut it's overnight rate by 1.5 to 5.0%. The Bank of Canada is pretty much guaranteed to cut at least another .50 next week to 1.75, while the US Federal Reserve is expected to halve it's key rate the week after to 0.50%.

NOTEWORTHY: The economic calendar unbelievably continues to go from bad to worse to worse to worse… Is there an echo in here? Let's have a brief look at this week's lowlights. The National Bureau of Economic Research made it official that the US economy has been in a recession with no end in sight since December 2007. The ISM Manufacturing Survey hit a new multi-decade low of 36.2, while the ISM Service Sector Survey looks just as dismal at an all-time low reading of 37.2. Auto Sales continue to crash – the November data stands at 10.2 Million units – another data point that is a multi-decade low and still dropping fast. Construction Spending and Factory Orders both declined in October. Wee kly Jobless Claims declined from 530k to 509k last week, but Continuing Claims rose again.

The monthly Employment was worse than imaginable on both sides of the border. The Unemployment Rate jumped from 6.5 to 6.7% in the US as Non-Farm Payrolls declined 533k in November, while the previous months' data was revised lower (additional job losses) by 200k. The Us economy lost close to 2 million jobs thus far in 2008 – 1.25 million of those were eliminated during the past 3 months. The Canadian Rate increased from 6.1 to 6.3% as Employment declined 70k. This number breaks a remarkable job creation streak for Canada and it is expected to be followed by more bad news going forward. Next week's schedule in the US will be highlighted by the Trade Balance, Producer Price Index and Retail Sales reports.

INFLUENCES: Trader surveys are excessively bullish. This is a strong negative. The Commitment of Traders reports showed that Commercial traders were net long 320k 10 year Treasury Note futures equivalents – an increase of 15k from 2 weeks ago. This is slightly positive for bonds. Seasonal influences are positive for most of December. The bond market is heavily overbought. The 10 Year Note came within a whisker of 2.5%, while the 30 Year Bond yield touched 3% according to my data provider. If we are not at or within a stone's throw of an intermediate top, then it might be time for me to try lawn bowling or scrabble instead of bond market forecasting. Please note the key word: intermediate! One item I would like to see in order to turn wildly bearish: the COT data to show commercials switching from a large long to a short position on the Long Bond contract.

RATES: The US Long Bond future traded up another 5 points to close at 133-13 last week, while the yield on the US 10-year note decreased another 28 basis points to 2.70%. The yield curve flattened again as long term yields continue to lead the way lower. The difference between the 2 year and 10 year Treasury yield was 178 basis points, which represents a flattening of 16 basis points. As short term yields get closer to zero, the shape of the yield curve is driven by the dynamics in long term rates.

BOTTOM LINE: Bond yields declined across the spectrum, while the yield curve was flatter due to a sharp drop in long term yields during the last month. The fundamental backdrop is just getting worse, which is supportive for bonds. Trader sentiment is now overly bullish, Commitment of Traders positions are slightly supportive and seasonal influences are positive. The market is way overbought. My bond market view is negative at this point.

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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© 2008 Levente Mady, All Rights Reserved

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