Treasury Dull Range bound Holiday Season Trading

By: Levente_Mady

On the financial sector front, there is just no relief in sight. Credit spreads remain under pressure. The stock price of Fannie Mae and Freddie Mac continue to plunge. Swap spreads are wider again. LIBOR is trading and levels indicative of severe financial distress. The good news is that the rest of the market is hanging in there. The bad news is that the present distress in the financial space is likely to spread to other sectors soon.

The Fed's fearless leader Ben Bernanke was telling the world that everything was under control last Friday. At the Central Banker's annual forum in Jackson Hole , Wyoming , the Fed Chief outlined his expectations of lower inflation going forward. At least for a day, markets seemed to be impressed as stocks and the US Dollar advanced. While I agree with him on the inflation front, looking beyond what will cause inflationary pressures to diminish is troublesome. Staying safe in the short end of the Treasury market has been and continues to be the most stable investment out there. At the expense of repeating myself, I would like to reiterate that as time passes by I remain convinced that the Fed will not raise rates in the foreseeable future and my trading is based on that premise.

NOTEWORTHY: The economic data was light and it continues to disappoint on both the (lack of) growth and inflation fronts last week. PPI increased by 1.2% in July and the annual rate stands close to 10%. For those of you who don't eat, drive, heat your homes or use energy for anything else, core PPI jumped 0.7% versus expectations of a 0.2% increase. The National Association of Home Builders Survey held steady at the all time low of 16 (on a 0-100 scale). Housing Starts plunged 11% to 965k, while building permits cratered 18% to 937k in July. Most of the plunge on both fronts was caused by a reversal of the temporary gains seen last month due to a building code change in New York . Nevertheless, Permits are leading Starts further down. Just like the financial sector, in housing there is no bottom in sight. Wee kly Jobless Claims declined 13k last week to 432k. This is the fourth week in a row where claims remained at this new higher plateau after spending most of the past 5 years below the 400k threshold. Leading Indicators declined 0.7% in July.

This has got to be one of the largest misses on forecasting this number. Most of the components that go into calculating this data series are known in advance of the release of the report. The miss is not only surprising but the fact that the year-over-year figure is now closing in on -3%, a level not seen since the 2001 recession. The Philly Fed's Manufacturing Survey rose 3.6 points to a -12.7 level that indicates a decline in activity in that region. In Canada the news was somewhat better. Canadian CPI edged up 0.3% in July as the annual tally now stands at 3.4%. The core CPI is still at a very tame 1.5% year-over-year level. Canadian Retail Sales managed to eke out a 0.5% increase in June.

However this figure is misleading as consumers were getting less for more money as sharp price increases mainly in the energy sector were the main culprit for this effect. The implications for the Bank of Canada are fairly clear based upon the latest Canadian economic data: expect stable to lower interest rates going forward. Next week's headliners will include housing data in the form of Existing and New Home Sales, the Conference Board as well as the University of Michigan Consumer Confidence Surveys , Durable Goods Orders, the second look at Q2 GDP and the July data on Personal Income and Spending.

INFLUENCES: Trader surveys remained neutral on bonds during the latest week. The Commitment of Traders reports showed that Commercial traders were net long 325k 10 year Treasury Note futures equivalents – an increase of 11k from last week. This is slightly supportive for bonds. Seasonals are positive for the rest of the month and into the beginning of September. As expected, the 10 year note yield continues to hover around 4%. My view is neutral; I expect more sideways action around 4% on 10 years. I hope to get a bit of a pull-back in prices in order to add to existing long positions in the short end, but it is likely that we have to wait till after Labour Day to get it.

RATES: The US Long Bond future traded up 6 ticks to close at 117-22, while the yield on the US 10-year note increased 3 basis points to 3.86%. The yield curve was essentially unchanged 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 increased 2 basis points to 147 last week.

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

BOTTOM LINE: Bond yields dropped lower, while the yield curve was unchanged last week. The fundamental backdrop remains bleak. Trader sentiment is neutral but COT positions as well as seasonal influences are supportive. The recommendation is to stay with the curve steepener, and continue to shun the weaker corporate credits. My bond market indicators are dead, 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

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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