U.S. Treasury Bond Market Continues to Power Ahead

By: Levente_Mady

The bond market continues to power ahead.  The long bond futures tested the 130 level for the first time in 20 months and look set for a slight breather heading into the long auction cycle next week.

While stock investors seem to be oblivious of the mounting evidence of a significant deflationary loss of economic momentum (or maybe they just choose to ignore it on purpose), the Federal Reserve will get its chance to vocalize its concerns following their Policy Meeting scheduled for next Tuesday. 

Last week we had the Bank of England tell us that they have no plans of budging on the rate front for the foreseeable future and maintained their active involvement on the Quantitative Easing front as a sign of the deep concern for the economic landscape in that country.  On the other hand the European Central Bank put the emphasis on the recent better than expected economic data as to the main reason for staying with what they deemed as the currently appropriate monetary policy.  The Fed does not have to say or do anything; the bond market is stealing their thunder by telling us that the extended period of time-frame for Zero Interest Rate Policy is getting gradually extended even further.  All one has to do is look at the shape of the US Treasury Yield Curve.  While the 2-10 yield differential has been relatively stable around 230-250, the 2 year note yield has just hit another all time (well for the last 50 years anyways) low at 0.5% this past week.  In other words the extended period for ZIRP has moved from a rolling 6-9 months to closer to 2 years…

NOTEWORTHY:  The economic calendar was mixed last week.  Personal Income and Spending were flat in June after the May figures on both data series were revised down.  Not exactly the type of data that makes one want to forecast 3-5% growth.  The ISM Surveys were essentially flat as well.  The Manufacturing Index declined a snick from 56.2 to 55.5, while the Services index ticked up marginally from 53.8 to 54.3.  Pending Home Sales declined another 2.6% in June on top of May’s massive 30% crash.  Not exactly the type of data that makes one want to jump with joy.  Weekly Initial Jobless Claims increased from 460k to 479k and look rather fragile at this juncture.  The monthly Employment Report was an unmitigated disaster.  While the official Unemployment Rate managed to stay unchanged at 9.5%; that was a number that should be entirely and completely disregarded.  If it wasn’t for the 1.2 million people that left the workforce during the past 3 survey months, the Unemployment Rate would be somewhere around 10.5% by now.  Analysts are slicing and dicing the data with census impacts and private versus government sectors, but the bottom line is that Non-Farm Payrolls declined 221k in June and another 131k in July.  They also missed consensus forecasts by more than 150k when you include the downward revisions of about 100k to the previous months’ data.  And the uptick in Weekly Claims does not bode well for the August report either.  And let’s not forget that the breakeven on Payrolls is not at 0 but somewhere closer to 150k when demographic influences are considered.  Not exactly the type of data that makes one want to start dancing in the streets.  In Canada, the Employment Report for July was also weak as about 10k jobs were lost and the Unemployment Rate ticked up a notch to 8%, although that should not be a massive surprise considering the stellar data of the recent months.  This week’s economic schedule will have the Trade Balance, CPI inflation, Retail Sales and the Michigan Consumer Sentiment Survey.

INFLUENCES:  Trader sentiment surveys we follow bounced up last week.  On a scale of 0-10, the surveys are at the 7.0 level, which is moving into overbought.  The Commitment of Traders report showed that Commercial traders were net long 223k 10 year Treasury Note futures equivalents – which is up 6k on the week.  This metric is neutral.  Seasonal influences are slightly negative for the first half of August.  The technical picture is positive as the bond futures continue to hold up well.  Bonds continue to trade higher lows and higher highs.  As a result, the technical picture remains solidly constructive.  With the long bond yield near 4% and the 10 year yield well below 3%, the market is acting like it could consolidate in this area before embarking on the next leg up.  We retain our positive bias on bonds over the longer term, but we moved to a marginally short trading position as of last Friday

RATES:  The US Long Bond future was up 1 point to 129-18, while the yield on the US 10-year note decreased 9 basis points to 2.82% last week.  The Canadian 10 year yield decreased 3 basis points to 3.08%.  The Canada-US 10 year spread moved in the US market’s favour.  The US 10 year yield is trading 26 bps lower than the Canadian 10 Year yield.  The Canadian 10 year is trading cheap to the US here.  The US yield curve was 4 basis points flatter with the difference between the 2 year and 10 year Treasury yield now at 231.  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 lower across the board last week, while the yield curve tilted flatter.  The fundamental backdrop looks increasingly supportive.  Trader sentiment was less positive this week; support provided by the Commitment of Traders data has evaporated while seasonal influences are neutral at best for the first half of the month.  The bond market had another solid week while testing the top end of its trading range.  My bias is neutral to slightly negative for the first half of August.

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

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