US Treasury Bonds Remain Range Bound

By: Levente_Mady

The Treasury market closed the week with slightly higher yields after a rally attempt that fizzled on Friday. With energy trading settling down somewhat – on the crude oil front anyways, the bond market started focusing on other news to drive the trading activity this past week. Earnings season on the stock side made for choppy trading along with continued problems in the financial sector. In spite of more grim news on the earnings front and a list of bankruptcy candidates in the financial sector that is multiple pages long, stocks started the week in relatively decent shape.

The bouncing stock market provided a convenient excuse for bond traders to beat up the market heading into Wednesday's and Thursday's 2 year and 5 year Treasury Note auctions. The auctions were well received, including above average non-competitive (i.e. Central Bank) purchases.

The rally rapidly fizzled on Friday as better than expected (but still dismal) economic data provided an excuse for another down-trade. There are a lot of folks out there who made good money on the commodity bull market of the past few years. Those guys have not been terribly happy during the past few weeks. Natural Gas plunged about 35% since the beginning of the month and some agricultural commodities had declines of a similar magnitude lately. While I do believe that we have reached peak oil several years ago, I don't reckon that the world will be running out of food and energy during the next week or two. The charts on commodities look ugly. With expectations of deepening global slowdown, talk of stagflation could soon be replaced by renewed worries about deflation.

The key report again next week will be the July Employment data. Consensus is looking for another up-tick in the Unemployment Rate from 5.5 to 5.6%, and another decline (-60k) in Non-Farm Payrolls. While the exact number is impossible to forecast, I feel confident that we are going to see ongoing downward revisions to the previous months' figures as well as substantially below trend (+175k) Payroll numbers. The Fed has never raised rates in a rapidly deteriorating employment environment like the one we are experiencing now. In spite of the fighting words, I don't think the Fed is about to change tactics on that front, especially heading into a presidential election campaign. The shorter maturities of the yield curve remained well supported. I am standing by my forecast that the Fed is months if not years away from changing the Fed Funds rate and when they do, they will be more likely lowering - not raising rates as the consensus would have you believe at this point.

NOTEWORTHY: The economic data was mixed relative to expectations last week. Leading Economic Indicators were reported at -0.1% - in line with expectations. The Fed's Beige Book economic report painted a glum economic landscape. Existing Home Sales declined 2.6% to 4.86 million - their lowest level in 10 years. New Home Sales were stronger than expected at 530k, but still just a stone's throw from a 16 year low. The economic bulls were busy pointing out that the revisions to the previous months' figures were also positive. Reality is that New Home Sales declined 65% from the peak and the market dynamics do not support a lasting turnaround yet. Wee kly Jobless Claims increased 34k to 406k last week.

Durable Goods Orders increased 0.8% in June, which was stronger than forecasts of a decline of 0.3%. The year over year figure however is below zero, which is not much to shout about. The Michigan Consumer Confidence survey bounced back from an all-time low of 56.4 to 61.2. FYI, 100 is neutral on this data series. Next week's headliners will include the Conference Board's Consumer Confidence Survey, Q2 GDP advance data and it will be a busy day on Friday with the monthly Employment report, the ISM Manufacturing Survey and June auto sales on tap.

INFLUENCES: Trader surveys remained neutral on bonds during the latest week. There was a slight increase in bullish sentiment, but it is far from excessive readings that could cause problems. The Commitment of Traders reports showed that Commercial traders were net long 372k 10 year Treasury Note futures equivalents – an increase of 120k from last week. The COT data is providing the bond market with a tail wind. Seasonals are turning sharply positive heading into the end of the month. After trading down below 4% on Thursday, the 10 year note yield settled back above 4%. The increase on the 10 year yield above 4% tilts the bias to bearish on the technical front. My view on the market is neutral; I expect more sideways action around 4% on 10 years.

RATES: The US Long Bond future traded down a half point to close at 113-26, while the yield on the US 10-year note increased 2 basis points to 4.10%. The yield curve was slightly flatter and I am expecting that it will retain a steepening bias. Long-short accounts can take advantage of the steepening trend by buying 2 year Treasuries against selling 10 year Treasuries on a risk weighted basis using cash or futures. This spread decreased 6 basis points to 140 last week.

CORPORATES: Corporate bonds remain suspect, especially the weaker credits.

BOTTOM LINE: Bond yields increased marginally, while the yield curve was slightly flatter last week. The fundamental backdrop remains bleak. Trader sentiment is neutral but COT positions and seasonal influences are positive. The recommendation is to stay with the curve steepener, and continue to shun the weaker corporate credits. My bond market indicators are dead neutral, so I am looking for the market to stay in a range around the 4% yield level on the 10 year Treasury Note until further notice.

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

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