U.S. Treasury Bonds Rally on Disturbingly Weak Fundamental Data

By: Levente_Mady

The bond market was stronger again last week as bonds rallied with help from more, persistent disturbingly weak fundamental data and an equity market that is still in search of a bottom.

Before I move on to bigger and better things, I just wanted to congratulate the G20 on doing their part to foster economic activity.  All those broken windows, burning cars and the rest of the damage that was done in spite of – or should we write “in addition to” – the billions of dollars that were spent on security.  That is a lot of money and trouble to be spent on a couple of Polaroid pictures…  Have these folks not heard of Photoshop?  Everyone could have stayed home, had a nice video conference call and photo-shopped those group pictures of the leaders to add to the smart communiqués that were released after the meetings.  The final question that begs to be asked is how environmentally friendly was all that anyways.  I certainly have to give credit to the protesters for demonstrating mostly on foot or bicycles.  On the other hand, I don’t reckon our fearless leaders travelled to Canada by sail boats or glide planes and it certainly looked like they did not ride their bicycles or horses from Muskoka to Toronto either!

Meanwhile, here we are with the first half of 2010 behind us.  I couldn’t help but notice at the beginning of the year that the bear wagon on the bonds was fully loaded.  It was too easy to take the other side of that trade.  Just like it was a lay-up to be negative on the Canadian Dollar with the endless herd of bulls as far as the eye could see.  I just wonder what kind of bonus what’s-his-name at Morgan Stanley will get this year for forecasting 5.5% 10 year Treasury yields in 2010.  And the Canadian dollar is down about 2% so far in 2010.

NOTEWORTHY:  The economic calendar continues to be pathetic.  The week started off on a decent note as Personal Income increased in line with expectations at 0.4% while Spending was up 0.2%.  The 10 point implosion on Consumer confidence from 63 to 53 was neither pretty nor expected.  Weekly Initial Jobless Claims increased from 459k to 472k last week and remain stuck on the wrong side of 450k.  The ISM Manufacturing survey dropped close to 4 points from 60 to 56 in May.  Consensus was looking for a 1 point drop.  The housing sector just can’t stop getting obliterated!  Pending Home Sales dropped 30% (!!!) in May while mortgage applications continue to break new ground on the down side even in the face of record low rates.  It is no longer about the price of credit, it is about availability.  The monthly Employment report was quite bleak in spite of the drop in the headline Unemployment Rate from 9.7 to 9.5%. 

That decline was due to a 625k exodus from the people in the labour force.  Without that decline in the workforce, the headline rate would be back to 10%.  All the details were ugly.  Payrolls declined 125k, Private Payrolls gained only 83k with lots of help from the Birth/Death adjustment (+145k), back months data was revised down and both Wages and Hours Worked declined to further exacerbate the weakness of the overall report.  In Canada, the data was also quite disappointing.  Canadian GDP was flat in April as it looks like the second quarter data is setting up for disappointment north of the border as well as south.  This week’s very light economic schedule will be highlighted by the ISM Services Survey and the Consumer Credit Report.

INFLUENCES:  Trader sentiment surveys we follow moved into overbought territory last week.  On a scale of 0-10, the surveys have climbed over 7.0, which is on the low side of overbought.  The Commitment of Traders report showed that Commercial traders were net long 277k 10 year Treasury Note futures equivalents – which is up 48k on the week.  This metric is neutral.  Positive seasonal influences worked well last week, but now they are forecasting a bit of a pullback for the first half of July.  The technical picture is positive as the bond futures continue to hold up well.  Resistance at 125 on the long bond futures was not much resistance after all, but the highs reached near 128½ could provide more of a fight.  On Friday the bonds lost close to 1 point in spite of a disappointing employment report which should have helped the bond market continue its rally.  With the long bond yield under 4% and the 10 year yield under 3%, the market is acting like it needs a rest or a pullback before embarking on the next leg up.

RATES:  The US Long Bond future was up 2 points to 127-05, while the yield on the US 10-year note decreased 14 basis points to 2.97% last week.  The Canadian 10 year yield decreased 10 basis points to 3.10%.  The Canada-US 10 year spread moved in the US market’s favour as it normally does in a declining yield environment.  The US 10 year yield is trading 13 bps lower than the Canadian 10 Year yield.  The US yield curve was 11 basis points flatter with the difference between the 2 year and 10 year Treasury yield now at 235.  The yield curve was ultra steep when 2s-10s were trading near 300.  Now it remains only very, very steep and struggling to normalize.

BOTTOM LINE:  Bond yields were lower across the board last week, while the yield curve tilted flatter again.  The fundamental backdrop looks increasingly supportive.  Trader sentiment is more positive this week; support provided by the Commitment of Traders data has evaporated while seasonal influences are negative for a brief period.  The bond market looks tired in the short term and it appears to be ready to take a breather.

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

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