U.S. Treasury Bonds Fall Despite Supportive Fundamentals

By: Levente_Mady

The bond market is testing the line in the sand drawn by the Bernanke Fed at 3% on the 10 Year Treasury note yield.  While stocks held their own with the Nasdaq closing positive for the 7th week in a row, bonds continued to trade in a leaky fashion.  There was all sorts of chatter about the government stress tests being flunked by most financial institutions, but until we see an official announcement, rumours of across the board insolvencies remain just that: rumours! 

The negative chatter sure did not seem to stand in the way of the negative tone in bonds.  What is not just innuendo is the fact that the US government shut down another 3 banks on the weekend, taking the tally to 27 bankruptcies thus far in 2009.  Yes, these are mostly smaller, regional banks and yes the administration has made it clear that they realized the error in their ways when they let Lehman Brothers go under, but that does not change the fact that these problems still seem to be gaining in momentum and events such as the Freddie Mac CFO committing suicide last week do not seem to be glowing votes of confidence that all is well now on the financial front.

Last Tuesday the Bank of Canada decided to slash its policy rate in half from 0.5% to 0.25% and it announced an aggressive quantitative easing program.  As per my comments in a BNN interview a few days before the announcement, the market impact was limited – with the most visible change coming on the US-Canada relative rate front.  Canadian rates are now very close to US rates across the yield curve, not offering much opportunity to trade that relationship at this point.  It was not at all surprising to see the Bank slash its forecast for this year as well as next.  The 2010 number is down from 3.8 to 2.5%, while it is now 2011 that is expected to rebound strongly to close to 5%. 

At the same time it was signaled that just like the US Federal Reserve Bank, the Bank of Canada is expecting to keep its benchmark rate near 0 for the foreseeable future or well into 2010 – whichever comes first.  It appears that their game plan is to see 5%+ growth before starting to move rates up.  In my humble opinion that playbook may take longer than a couple of years to develop.  Staying on the central bank front, next week it will be the US Federal Reserve Bank’s turn to have a policy meeting and the usual announcement to go with it.  If the Bernanke Fed retains the character it showed thus far, we can expect further dovish – i.e. stimulative – language to come out of this one as well.  There is certainly one reason not to short the bond market.  The other one would be the month end buying by indexers that should support prices as well.

NOTEWORTHY:  The economic calendar was very light last week and it was mostly in line with expectations.  Leading Indicators dropped 0.3% in March.  It has been 10 months since this series had a positive print.  The road ahead is anything but smooth according to this forward looking indicator.  Weekly Initial Jobless Claims jumped 27k to 640k after last week’s sharp drop, while Continued Benefits continue to skyrocket and are now well over 6 million as they increased another 100k or so last week.  The housing data was mixed.  Existing Home Sales dropped 3% from a downward revised 4.71Million units to 4.57Million last month, while New Home Sales were stable at an upwardly revised prior month’s figure of 356k.  Durable Goods Orders showed a small decline of 0.8% as the previous month’s estimate was revised down from 3.4 to 2.1%. 

In Canada, Retail Sales were essentially flat (+0.2% to be exact) in March.  In today’s adverse environment that must be viewed as a relief.  Next week’s schedule will be much busier and it will be highlighted by consumer confidence reports, the first cut at the Q1 Gross Domestic Product, Personal Income and Spending data as well as the Manufacturing Sector Purchasing Managers’ report.  This coming month we will have to wait until the second Friday for the key monthly data on the employment scene both in Canada and the US.

INFLUENCES:  Trader sentiment surveys remained stuck in neutral territory.  Just like the bond market, this data series has been stuck in neutral and it is going sideways fast.  In a perverse way, it has been an excellent predictor of the range-bound action in bonds.  The Commitment of Traders reports showed that Commercial traders were net long 336k 10 year Treasury Note futures equivalents – an in crease of 62k from last week.  This is slightly supportive.  It is also telling us that the smart money is buying the dip to the bottom of the range here.  Seasonal influences are negative.  The technical picture is fragile as the market is testing the lower band of the recent trading range at 124.  I expect the 124 to 130 trading range to persist for the Long Bond futures, which I suppose plants me in the slightly bullish camp here.

RATES:  The US Long Bond future faded a point to 124-09, while the yield on the US 10-year note increased 3 basis points to 2.98% during the past week.  The Canadian 10 year yield was unchanged at 3.02%.  The US yield curve was steeper as the difference between the 2 year and 10 year Treasury yield increased 3 basis points to 202.  The 200 level appears to be the magnet in this relationship for now.

BOTTOM LINE:  Bond yields increased somewhat, while the yield curve was pretty much unchanged last week.  The fundamental backdrop remains weak, which is supportive for bonds.  Trader sentiment is neutral; Commitment of Traders positions are supportive and seasonal influences are negative.  My bond market view remains neutral.

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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© 2009 Levente Mady, All Rights Reserved

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