U.S. Treasury Bond Market Stabilises

By: Levente_Mady

The bond market stabilized last week.  Although the economic data schedule was rather busy, trading was more heavily influenced by the Treasury auctions and month end activity as the second tier fundamental news did not offer any major surprises.  While the volatility in the currency markets continued, the chop was more sideways and less directional.  Trading in stocks and bonds had the same directionless character.  The Treasury auctions were somewhat strange during this cycle.  Normally the shorter maturities are relatively well received and the longest tranche can hit some bumps.  Last week the 2 year auction was mediocre, the 5 year was sloppy but the 7 year bonds were very well received on Thursday setting up – as advertised - a seasonal bond rally into month end very nicely.

Next week in addition to the full slate of economic reports the US has midterm elections on Tuesday and the Fed has a policy meeting that will end with a press release on Wednesday.  This meeting garners more interest than usual since the implementation of the Zero Interest Rate Policy almost 2 years ago.  The Fedsters are expected to announce further details of what is commonly known as Quantitative Easing, chapter 2 – QE2 for short.  At the expense of repeating myself, I can’t believe that these people can have such a lack of common sense that they don’t realize how ineffective they have been and that QE2 might postpone, but it certainly won’t solve the problems the US and Global economies are experiencing.  The worst part however is that the general public seems to believe that along with the government (I suppose in a way they are part of the government) they will fix all our problems.  According to the (Fed) model I follow, the 10 Year Treasury Note remains close to 2 standard deviations cheap to the SP500 dividend yield.  Bonds are cheap here and they have largely worked off some of the overbought readings that were the result of the 20%+ rally from early April to late August.  They should continue to have the Fed’s support.

NOTEWORTHY:  The economic calendar was mixed last week.  Existing Home Sales were reported slightly stronger than expected at 4.53 million units, while New Home Sales also moved up about 7% to 307k units.  House Prices were little changed as one survey reported a marginal increase, the other one a slight decline.  Consumer Confidence remains stuck in heavy mud as the Conference Board survey ticked up a couple of points to 50.2 (100 is a neutral reading on this) while the Michigan survey declined a shade to 67.7.  The Fed’s regional surveys improved somewhat, but remain close to neutral readings.  Durable Goods Orders looked good at first blush with a headline increase of 3.3%, but the ex-transport component actually declined 0.8%.  The airplane orders that juiced the headline numbers will not be delivered for years.  Weekly Initial Jobless Claims dropped 21k to 434k, which is a good sign for the labour market as this series dips below the recent 450k equilibrium this data series has been wrestling with for months now.  The preliminary figure for the Q3 GDP was reported close to expectations of 2% and it was chiefly driven by a 2.6% increase in Personal Consumption.  So much for the consumers tightening their belts!  In Canada, the August GDP increased in line with expectations of 0.3%.  The Canadian economy is looking at a growth rate of 1.5 to 2% in Q3 – very similar to the US growth profile.  This week’s economic schedule will include the report on Personal Income and Consumption, the ISM Manufacturing and Services surveys and the monthly Employment report.

INFLUENCES:  Trader sentiment surveys we follow declined a good chunk last week.  On a scale of 0-10, the surveys dropped close to 1 point to the 5.5 level, which is solidly neutral.  The Commitment of Traders report showed that Commercial traders were net long 25k 10 year Treasury Note futures equivalents – which is a decrease in shorts of 140k over the past week.  This metric is moving to neutral.  Seasonal influences are negative for the first week of November.  The technical picture is neutral as the bond futures remain stuck in a 130-137 range.  We are holding a short position on the December 131 puts for now.  We are expecting the recent range to remain intact for the next couple of weeks as the bonds have now worked off some of the recent overbought indicators on the sentiment and COT position fronts.

RATES:  The US Long Bond future was down close to a point to 130-30, while the yield on the US 10-year note increased 4 basis points to 2.60% last week.  The Canadian 10 year yield increased 7 basis points to 2.81%.  The Canada-US 10 year spread moved in the US market’s favour.  The US 10 year yield is trading 21 bps lower than the Canadian 10 Year yield.  The Canadian 10 year is still trading cheap to the US here.  The US yield curve moved a shade steeper, with the difference between the 2 year and 10 year Treasury yield out 5 bps to 226.  The new range is forming at 200 to 225 as the curve is struggling to normalize.  Meanwhile the long end of the yield curve is still ultra steep as the difference between 10s and longs was stable near 138 bps.

BOTTOM LINE:  Bond yields edged slightly higher last week, while the yield curve tilted slightly steeper.  The fundamental backdrop looks solidly supportive.  Trader sentiment slid back to neutral this past week; the Commitment of Traders data is less of a drag but still not helping, while seasonal influences are negative this week before turning positive again.  I remain neutral on the bond market.

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

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