U.S. Treasury Bonds Recovery from Deeply Oversold Levels

By: Levente_Mady

The bond market recovered from deeply oversold levels last week.  Former support at 3% on the 10 Year Treasury Note will be the first major resistance level to watch.  The yield curve on the other hand maintained its steepness as yields declined across the maturity spectrum.  The economic data might look good from far but it is far from good so the main concern for the bond market is not an imminent recovery but a continued deterioration of the credit quality of government bonds as more and more of the excesses of this enormous credit bubble continue to migrate from the private to the public sector.  Look for real yields to expand.

The economic data has mostly exceeded pathetic expectations for the past couple of months.  Now the forecast bar has been raised somewhat from fully pathetic to three quarters pathetic and we are starting to see below consensus economic data again.  Meanwhile the revisions of the older data continue to be consistently negative.  The doctored earnings season is pretty much over and done with on the equity front, so catalysts for further equity appreciation will be more difficult to come by.  We have also seen substantial narrowing for corporate bond spreads indicating that bond buyers have returned to higher risk portfolios.  

Commodities have also rebounded, some of them (crude oil for instance) are up close to 100% from the lows.  On the fundamental front, there are no signs of an impending turnaround.  The largest portion of the economy – the consumer – remains in dire straights as job losses continue to mount and record consumer debt levels are leading to further defaults.  The volumes on the international trade front remain in a declining phase.  With Industrial Production at record low levels, growth in this sector will be extremely difficult to come by for years to come.  Local levels of government are faced with rapidly declining revenues and are forced into budget cutbacks as a result.  The big question is where will any type of sustainable growth come from?  I don’t know; I just don’t know!

NOTEWORTHY:  The economic calendar was busy last week.  The US Trade Balance increased marginally by $1.5 Billion to $27.6 Billion in March after dropping by 60% in 10 months.  The bad news on the trade front is that both exports and imports continue to drop.  The premier data point of the week was the Retail Sales report.  It was disappointing on a number of fronts.  Sales declined 0.4% in April while the March data was revised down from -1.1 to -1.3%.  The latest data point was disappointing because it continues to be negative and weaker than expectations of a flat reading.  The ex-auto component was also weaker than forecast and revised down.  The patient – the consumer – still does not have a pulse!  Weekly Initial Jobless Claims jumped 32k lower to 637k, while Continued Benefits were up another 200k+ to over 6.5 Million. 

The inflation reports were a mixed bag, but they drew very muted market reaction.  Headline PPI and CPI are both well into negative territory and still falling but the core readings remain sticky with PPI stuck above 3% and CPI near 2% year over year.  Industrial production declined 0.5% in April as the March data was revised down from -1.5 to -1.7%.  Since the end of 2007, there was one positive reading on this series.  Understandably Capacity Utilization dropped to another record low of 69.1% in the 42 year history of this economic indicator.  With reading such as this it is difficult to fathom how the industrial sector could contribute to a turnaround any time soon.  The Michigan Consumer Sentiment Survey climbed 3 points to 67.9.  100 is neutral on this one!  In Canada, the Trade Balance improved from flat to a surplus of $1.1 Billion in March.  Unfortunately the improvement was due to a 4.5% decline in imports while exports declined a lesser 1.8%.  Manufacturing Shipments declined 2.7% in March and they are off 16% from a year ago.  This week’s schedule will be very light and it will include some housing data and the report on Leading Economic Indicators.

INFLUENCES:  Trader sentiment surveys moved lower again this week.  While longer term this is supportive, in the short term it has more room to move before it becomes overdone.  The Commitment of Traders reports showed that Commercial traders were net long 377k 10 year Treasury Note futures equivalents – an increase of 6k from last week.  This is somewhat supportive.  It is also telling us that the smart money is not even remotely interested in heading for the hills as yields rose.  Seasonal influences are turning positive.  The technical picture is still less than constructive, but the 120 target level managed to hold for now as the market recovered slightly from a severely oversold state.  As per last week’s comments, I am staying with my long bias for the Treasury bond market at this level.

RATES:  The US Long Bond future gained over two and a half points to 122-29, while the yield on the US 10-year note decreased 16 basis points to 3.13% during the past week.  The Canadian 10 year yield was 6 basis points lower at 3.09%.  The US yield curve was flatter as the difference between the 2 year and 10 year Treasury yield decreased 3 basis points to 228. 

BOTTOM LINE:  Bond yields turned lower, while the yield curve was slightly flatter last week.  The fundamental backdrop remains weak, which is supportive for bonds.  Trader sentiment continues to move toward bearish territory – which is positive; Commitment of Traders positions are supportive and seasonal influences are becoming positive.  My bond market view is positive.

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

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