U.S. Treasury Bonds Lower, Despite Supportive Fundementals

By: Levente_Mady

The bond market moved up last week as yields dropped across the curve.  In spite of stronger than expected economic data, another auction cycle and a rock solid stock market, bonds spent most of the week in positive territory and managed to hold on to their gains better than the previous week.

The economic data indicates that growth could exceed 3% in the third quarter of 2009.  With all the incentives and programs that is not surprising at all.  However, the Consumer continues to be stretched, stressed and desperate as the job market is not showing any improvement (Initial Jobless Claims have been stuck in a disturbingly high 550k-600k range for most of the summer) as personal bankruptcies and home foreclosures continue to trend higher.  The dead cat bounce in the economy is expected to be short lived as the marginal utility of further spending programs will continue to become increasingly ineffective.

In last week’s commentary we wondered 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.  Last week the FDIC shed some light on its finances and they are not good.  Even with a special levy of $5.6 Billion, reserves at the FDIC fell from $13 Billion to $10.4 Billion by the end of June.  And that number does not include some of the bigger institutions that had to be rescued in July and August. 

So the kitty is probably closer to $3Billion and still falling rapidly.  No need to fear as Congress has approved a $100 Billion line of credit for them already and they also have access to a further $500 Billion from the good folks at the Federal Reserve.  A 100 Billion here and a 100Billion there; before you know it, we are talking about some serious money.  As an aside, another 3 financial institutions failed last week.  Meanwhile financial stocks continue to rocket to new highs.

In case anyone was wondering, as per recent practice, the Treasury auctions were very well received, with those wicked Central Banks taking over 50% of the offerings again.  Add to that some domestic buying driven by month end term extensions and we had a decent tone in Treasuries for most of the week.

NOTEWORTHY:  The economic calendar was mixed to stronger than consensus last week.  Consumer Confidence rose somewhat after a 2 month lapse.  The Conference Board Survey jumped 7 points to 54, while the Michigan Consumer Confidence Survey moved up a couple of points to 65.7.  Let’s not forget that both of these series are still hugely below the 100 level that is considered to be neutral.  Durable Goods Orders also increased sharply, moving up 4.9% on the strength in aircraft and automobile orders.  On the housing front New Home Sales increased a higher than expected 7% to 433k units.  Weekly Initial Jobless Claims decreased 10k from 580k to 570k last week. 

The second quarter real GDP figures were unchanged at -1% but the downward revision in the Deflator (the inflation measure) lowered the nominal GDP decline from -0.8 to -1.0.  Personal Income was flat in July, while Spending was up 0.2% - boosted by automobile purchases as the “Cash for Clunkers” government program provided the incentive.  This caused the famous Savings Rate to fall from 6 to 4.2% in a span of 2 months.  Perhaps some new government incentives – cash for houses (we actually have that one already), cash for vacations, cash for cosmetic enhancements – might do well to drive the savings rate back below zero…  In Canada, the Current Account Deficit jumped to a record $11.2 Billion.  The Canadian Dollar took the news in stride.  This week’s schedule will be highlighted by the ISM Purchasing Manager Surveys and the monthly Employment Report.

INFLUENCES:  Trader sentiment surveys became more bullish last week.  On a scale of 1-10, the surveys I follow are a whisker below 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 360k 10 year Treasury Note futures equivalents – a drop of 77k from last week.  This is still positive.  Seasonal influences are positive right through September.  The technical picture is neutral as bonds are probing the top of the recent trading range again.  A close above 121 on the Long bond future opens the door to test major resistance at 124.  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 up 1½ points to 120-10, while the yield on the US 10-year note decreased 12 basis points to 3.45% last week.  The Canadian 10 year yield was also lower, falling 9 basis points to 3.39%.  The Canada-US 10 year spread shrank 3 basis points to 6.  The US yield curve was flatter as the difference between the 2 year and 10 year Treasury yield decreased 5 basis points to 243. 

BOTTOM LINE:  Bond yields were lower 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

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