U.S. Treasury Bond Market Kept Positive by Friendly Inflation Data

By: Levente_Mady

The bond market ended flat after spending most of the time trying to move up last week.  Friendly inflation data and a confirmation of solid international demand kept the market in positive territory for most of the week.

We can have a debate about how inflation should be best measured and all the monkey business that is going on with the government manipulating the numbers, but I will just try to ignore that discussion for the time being.  I will just pretend that the statistics are what they are and as per the latest CPI data inflation stands at -2.1% year over year.  Using that data puts the real 30 year Treasury yield at very close to 6.5% - which is the highest it has been in close to 3 decades.  There are 2 key observations that I would like to make here: 1, the historically high (and increasing) real yields are reflecting the deteriorating credit quality of Treasury bonds and 2, these extremely high real yields are not something the doctor ordered to help the recovery rolling.  It is a catch-22: the more stimulus, the higher the real Treasury yield will rise, which will further impede any kind of lasting recovery.

On the bank shutdowns front, the authorities just continue to wield the big ax.  I am not exactly sure where the count is exactly – I believe it was last seen at 81 – but there seems to be no slowing down on this front.  Another 4-5 banks were euthanized last week.  One big problem with the trend is that these stinky dead fish floating down the river are just getting larger and larger.  One has to wonder how long before the good folks at the Federal Depositary Insurance Corp will be asking the government for many more billions in funding in order to be able to continue to guarantee the depositors’ funds in these institutions as to avoid a banking panic.

On second check the experts that were discussing the Fed preparing to pare back their asset purchases supporting the credit markets did not turn out to be quite right.  While the Fed did announce that they plan to wind up their Treasury Bond purchasing program by October at their last policy meeting, they followed it up with also announcing that they will continue to support the Asset Backed Securities portion of the Fixed Income market.  As per last week’s comments, it certainly appears that for the time being the Treasury market is managing to hold up in decent fashion even without ongoing Fed support.  Last week’s international funds flows report certainly confirmed what we saw from the recent Treasury Note and Bond auctions: international investors – both Central Banks and others as well – continue to be massive buyers of Treasuries.

NOTEWORTHY:  The economic calendar was mixed last week.  Manufacturing surveys from NY state and Philadelphia area turned positive, suggesting an above 50 reading on the National ISM Manufacturing survey due out in a week and a couple of days.  On the housing front Housing Starts and Building Permits declined and missed expectations while Existing Home Sales surged over 7% and bettered expectations.  The inflation data in the US remains tame on most fronts.  Last week’s PPI report showed that Prices at the Wholesale level declined a much larger than expected 0.9% in July. 

The core component also declined by a lesser 0.1% as the experts looked for a small increase on that front.  Weekly Initial Jobless Claims increased 15k from 561k to 576k last week.  Leading Economic Indicators increased by 0.6% - the fourth consecutive month of a positive reading.  In Canada, the Consumer Price Index fell 0.3% in July for a 12 moth decline of 0.9%.  This is the lowest reading in this data series since the 1950s.  Core inflation was flat last month while the annual figure slid from 1.9 to 1.8% and it will likely continue to decline.  This is another ongoing supportive influence for the bond market.  This week’s schedule will be highlighted by consumer sentiment survey, personal income and spending data as well as more Housing Data in the form of New Home Sales, the Durable Goods Orders report as well as the revisions to the preliminary Q2 GDP report.

INFLUENCES:  Trader sentiment surveys became more bullish last week.  On a scale of 1-10, the surveys I follow are near 4.5 – which is solid neutral territory.  I expect sentiment to be somewhat supportive going forward as there is plenty of room to rise before this metric becomes overdone.  The Commitment of Traders reports showed that Commercial traders were net long 437k 10 year Treasury Note futures equivalents – a slight decrease of 4k from last week.  This is positive.  Seasonal influences are positive right through September.  The technical picture is neutral as bonds remain in a trading range.  Last week we tested the upper end of the recent range, but managed to slide back on Friday.  I expect that we should get some follow through to higher prices in the long bond during the weeks ahead.

RATES:  The US Long Bond future was essentially unchanged at 118-26, while the yield on the US 10-year note increased 1 basis point to 3.57% last week.  The Canadian 10 year yield was also steady at 3.48%.  The Canada-US 10 year spread increased 1 basis point to 9.  The US yield curve was flatter as the difference between the 2 year and 10 year Treasury yield decreased 2 basis points to 248. 

BOTTOM LINE:  Bond yields were little changed last week, while the yield curve became slightly flatter.  The fundamental backdrop remains weak, which is supportive for bonds.  Trader sentiment is moving up to neutral – which is somewhat positive; Commitment of Traders positions are supportive and seasonal influences are bullish.  I recommend keeping the long bonds that were purchased back in June.

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.

MF Global Canada Co. is a member of the Canadian Investor Protection Fund.

© 2009 Levente Mady, All Rights Reserved

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.