U.S. Treasury Bond Market Oversold, Strong Seasonal Influences Supportive of a Rally

By: Levente_Mady

The bond market sold off another three and a half points during the course of last week before managing to recover to almost unchanged for the week.  It was one of the strangest weeks of trading activity that I have seen in a long time.  While the economic data offered no major surprises to drive substantial moves in yields, the focus appeared to be on the Treasury auction calendar. 

Tuesday we had a 2 Year Note auction to the tune of $40Billion with stellar results – the amount of bids received was high side with $2.94 in bids for every dollar auctioned, the bidding was aggressive as the bonds sold at a higher than expected price and foreign central banks showed up in force taking over 50% of the notes sold.  Traders looked at the auction then turned around and pummeled the market.  Wednesday’s 5 Year Note auction was equally well received with substantially higher than average participation and aggressive bidding, but again traders were not happy and sold the market down hard.  Finally, Thursday’s 7 Year Note auction was perhaps best described as average, but with supply out of the way, the market started to stabilize and recover.  By Friday there were no sellers left and the Long Bond futures managed to rally 2 points.

As y’all probably heard by now, GM is going bankrupt next week.  Nobody seems to be concerned…

NOTEWORTHY:  The economic calendar was mostly in line with forecasts last week.  We had a couple of headlines on the housing front.  It was not a big surprise that house prices remain under pressure.  Existing Home Sales were stable around 4.68 million annualized units.  Meanwhile New Home Sales are doing nothing to support theories of the housing sector turning around.  New Home Sales were pretty much the same in April as the downward revised figure from March around 350k.  Let’s take a step back for a few seconds and take a look at the bigger picture here. 

The latest Building Permits were 494k, Housing Starts were 458k and New Home Sales were at 352k.  Something does not add up here.  If this trend remains in place, supply will continue to overwhelm demand and regardless of the degree of affordability, prices could end up at 0.  Meanwhile Consumer Confidence is climbing in step with the stock market.  The Conference Board Consumer Survey jumped a massive 14 points to 54.9 in May.  Let’s not forget that 100 is a neutral reading on this data series.  Weekly Initial Jobless Claims remained elevated as they declined 13k to 623k, while Continued Benefits were up another 110k+ to 6.79 Million.  What this means is that while layoffs have stabilized at very high levels, nobody seems to be hiring to help balance the other side of the ledger. 

In other words, if Non-Farm Payrolls for May – due to be reported this coming Friday - will decline by anything less half a million, we should break out the champagne, jump with joy and start dancing in the streets!  Durable Goods orders increased by 1.9% in April, but the March figure was revised down to a 2.1% decline, leaving the 2 month average essentially unchanged.  The “core” Durable Goods Orders (excluding the often volatile transport component) only increased 0.8%, while the March figure there was revised down from -0.6 to -2.7%!  No green shoots there. 

The Q1 GDP figure was revised from -6.1 to -5.7%, which was below forecasts of a 5.5% decline.  It should also be noted that the Deflator (the inflation component) was revised down to 2.8 from 2.9%.  The Chicago Purchasing Managers Index crashed from 40.1 to 34.9 in contrast to expectations of further improvement to 42.  In Canada, the Q1 Current Account Deficit jumped to a record $9.1Billion (36.2Billion annualized rate).  Naturally that helped our dollar gain a couple of cents against its US counterpart before the report and another couple of cents after the report.  Go figure!  I suppose we should look for further strength in the C$ to fuel further records on the Current Account deficit front.  This week’s schedule will include data on Consumer Spending and Credit as well as the ISM Surveys and the monthly Employment report.

INFLUENCES:  Trader sentiment surveys moved further into bearish levels this week.  This is supportive from a contrarian perspective.  The Commitment of Traders reports showed that Commercial traders were net long 507k 10 year Treasury Note futures equivalents – an increase of 73k from last week.  This is quite supportive.  It is also telling us that the smart money continues to accumulate long positions as yields rise.  Seasonal influences are positive.  The technical picture is still less than constructive as the market broke again to new lows for 2009.  The high yield on the 10 Year Treasury Note was 3.74% on Wednesday.  If I liked the market at 3.5%, I can safely say that I loved it at 3.75%.   If we get to 4%, load up the 18 wheeler with bonds!

RATES:  The US Long Bond future declined less than a quarter point to 119-03, while the yield on the US 10-year note increased 1 basis point to 3.46% during the past week.  The Canadian 10 year yield was 13 basis points higher at 3.38%.  The US yield curve was stable as the difference between the 2 year and 10 year Treasury yield decreased 2 basis points to 255. 

BOTTOM LINE:  Bond yields jumped sharply before recovering to unchanged, while the yield curve was also little changed by the end of the week.  The fundamental backdrop remains weak, which is supportive for bonds.  Trader sentiment moved further into bearish territory – which is positive; Commitment of Traders positions are strongly supportive and seasonal influences are positive.  I recommend buying long bonds here.

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

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