Surging Stock Markets Push Bond Yields Higher
Interest-Rates / US Bonds Jul 25, 2010 - 08:47 PM GMTBy: Levente_Mady
The bond market was off slightly last week as a surging stock market knocked yields 3-6 basis points higher for the week. The bond futures traded up to new 18 month highs on Wednesday before settling back a couple of points during the last two trading sessions before the weekend. While stocks and commodities finished a positive week, the bond market continues to scream double dip and deflation. With the 2 year yield just a snick north of one half percent the bond market is starting to tell us that the Fed is increasingly likely to stick with its Zero Interest Rate Policy for the foreseeable future. Until the next wave of credit concerns hits the market, bonds will continue to have a positive fundamental backdrop.
The Bank of Canada raised its benchmark overnight rate by 25 basis points for the second consecutive meeting, pegging the rate at 0.75%. While I heartily agree that they should not keep rates at 0%, on the other hand considering what is transpiring on the fundamental front, it looks to me like they are jumping the gun again and will be backpedalling sooner than later. I just don’t see how the Canadian economy can grow at or above trend growth with most of the developed world – including the US – quickly losing momentum. The BOC has been there before, but did not seem to have learned anything. Not surprisingly the usual uncertainty mumbo-jumbo accompanied the rate hike. Although the strategist community appears to be forecasting another rate hike or two, I would be surprised to see another one based on the latest economic data.
Just a quick note on the biggest farce I have seen in a long time: the European Bank Stress Test! What a total and complete joke! How anyone can take this stuff seriously is entirely beyond me. Did anyone happen to see how much money they wasted on this exercise? I am glad I don’t have to pay for it.
NOTEWORTHY: The economic calendar continues to disappoint. Housing just keeps going from bad to worse and worse. I am not quite sure how it is possible, but its like the old Timex watch, it takes a lickin’ and keeps on tickin’ – down relentlessly. The National Home Builders’ Survey dropped 2 points to 14. Only a snick over a dozen points to zero! Housing Starts were originally reported at 593k units for May. That figure was revised down to 578k and the June data came in way below the revision at 549k. Existing Home Sales ONLY plunged 5% versus an expected 10% drop. Forecasters were dancing in the streets to celebrate the so-called outstanding data. Stocks rallied 2-3% on the news. Unbelievable! After dropping below 450k for one week in a row, Weekly Initial Jobless Claims increased from 427k to 464k last week as seasonal adjustments whipped around. The Conference Board’s Leading Economic Indicators dropped for the second time in 3 months, declining 0.2% in June.
The ECRI Leading Indicators are putting the chance of a double dip recession at around 70%. I think they are too optimistic. In Canada, after the lousy data last week, we got more bad news this past week. Retail Sales fell for the second month in a row. They dropped 0.2% in May after a downward revised and hefty 2.2% drop in April. At the same time, inflation is disappearing just the same way as it is evaporating in the rest of the world. Canadian CPI declined 0.1% both on the headline and core fronts in June, taking the year over year figures down to 1.0% and 1.7% respectively. Gravity is taking over in the Canadian economy and housing. It was just a matter of time. It looks like Q2 in Canada may be closer to flat than the 3-4% that was recently forecast. This week’s economic schedule will be highlighted by New Home Sales, Consumer Confidence Surveys, Durable Goods Orders and the first estimate of the Q2 GDP.
INFLUENCES: Trader sentiment surveys we follow were stable last week. On a scale of 0-10, the surveys are at the 7.0 level, which is on the low side of overbought. The Commitment of Traders report showed that Commercial traders were net long 247k 10 year Treasury Note futures equivalents – which is up 79k on the week. This metric is neutral. Seasonal influences are positive for the rest of July. The technical picture is positive as the bond futures continue to hold up well. Support at 125 held, the technical picture remains solidly positive. With the long bond yield near 4% and the 10 year yield near 3%, the market is acting like it could consolidate in this area before embarking on the next leg up. We retain our slight positive bias on bonds.
RATES: The US Long Bond future was down 1 point to 127-06, while the yield on the US 10-year note increased 4 basis points to 2.99% last week. The Canadian 10 year yield increased 6 basis points to 3.22%. The Canada-US 10 year spread moved in the US market’s favour. The US 10 year yield is trading 23 bps lower than the Canadian 10 Year yield. The US yield curve was 6 basis points steeper with the difference between the 2 year and 10 year Treasury yield now at 241. The yield curve was ultra steep when 2s-10s were trading near 300. Now it remains only very, very steep, trapped in a range and struggling to normalize.
BOTTOM LINE: Bond yields were slightly higher across the board last week, while the yield curve tilted steeper. The fundamental backdrop looks increasingly supportive. Trader sentiment was steady with a positive bias this week; support provided by the Commitment of Traders data has evaporated while seasonal influences are positive for the rest of the month. The bond market traded up to new highs before settling back a couple of points. My bias remains slightly bullish going into month end.
By Levente Mady
lmady@mfglobal.com
www.mfglobal.ca
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