U.S. Bond Market Trades in Choppy Narrow Range

By: Levente_Mady

The bond market has settled into a relatively narrow but choppy trading range over the past 5 weeks.  The Treasury Bond auction cycle consisting of 3, 10 and 30 year tranches was well received, but the slightly disappointing 30 year auction appears to have prevented the market from breaking out of its recent narrow range.  Even the onslaught of disappointing economic news could not provide enough motivation for the market to break out to the upside.  Consequently, it looks like sideways action remains the path of least resistance.

The bonds remain cheap on a relative basis to stocks.  The risk trade appears to be fail proof as the stock market refuses to tick down for more than a couple of hours since the beginning of December.  Precious metals look a tiny bit more fragile, but the stock market is in record rally mode.  The fixed income markets are not going anywhere, but the more fragile markets such as the weaker European credits now appear to have some Chinese support to keep them from falling apart for now.  In the US, the municipal (i.e. state and local government) bonds are struggling, but the corporate bond sector is looking at high levels of new issuance along with the steady Treasury supply. 

NOTEWORTHY:  The economic calendar was busy over the past couple of days.  The majority of the reports did not meet expectations.  The latest surveys seem to indicate that 2 groups (not surprisingly) continue to miss out on the liquidity driven recovery.  The NFIB Small Business Index dropped a point from 93 to 92 in December, while the Michigan Consumer Confidence also declined a couple of points from a lowly 74 to an even lowlier 72. Weekly Initial Jobless Claims increased 35k to 445k – as it looks like it may be gravitating back toward the 450k level that it was stuck at for months on end.  The US Trade Deficit narrowed a snick as it was reported well below expectations at $38 Billion.  This was a strong report from an economic perspective as it was mainly driven by higher export – which implies stronger economic activity.  The inflation landscape is a bit of a mixed bag.  The relentless increase in commodity prices – especially energy – are showing up in a big way on the headline figures especially at the wholesale level.  Headline PPI increased a hefty 1.1% while the core rate was much more subdued at +0.2%.  CPI was a similar story on a smaller scale.  Headline CPI jumped 0.5%, while the core measure barely increased 0.1%. 

The moral of the story is that rising commodity prices are starting to squeeze margins but they are not yet getting passed on to the consumer with the exception of oil related products.  That is certainly an item that is acting as a stiff tax for consumers and could be contributing to the ongoing lousy consumer sentiment landscape.  Retail Sales increased a less than forecast but still respectable 0.6% headline figure and 0.5% ex-autos.  Retail Sales have increased substantially for 6 months in a row and the disappointing job market indicates that this run could be nearing an end soon.  Capacity Utilization and Industrial Production were both up substantially as they were aided by a massive weather related increase in the Utilities sector.  In Canada, the Trade Deficit was lower than expected at $100 Million.  The housing market in Canada is showing signs of significant slowing that may be related to a hefty increase in interest rates over the past few months.  Building Permits declined 11% in November after falling over 6% the month before that.  Housing Starts also fell about 10% in December.  This week’s economic schedule will include mostly housing related reports such as Housing Starts and Existing Home Sales as well as a couple of Manufacturing surveys in the Northeast.

INFLUENCES:  Trader sentiment surveys we follow held stable last week.  On a scale of 0-10, the surveys were hovering at the 4.0 level, which is close to neutral.  The Commitment of Traders report showed that Commercial traders were net long 222k 10 year Treasury Note futures equivalents – which is an increase of 19k.  This metric is neutral.  Seasonal influences are mixed during January.  The technical picture remains fragile, as the bond futures continue to struggle to find solid support.  We obviously started buying bonds too early and sitting somewhat under water.  The market has settled into a 119 to 122 range over the past couple of weeks.  The old support around the 125 futures price (3% yield level on the 10 year Note) will be the first key resistance to be mindful of.  We are neutral holding a long position heading into the second week of 2011.

RATES:  The US Long Bond future was practically unchanged at 120-29, while the yield on the US 10-year note was also unchanged at 3.32% last week.  The Canadian 10 year yield increased 8 basis points to 3.27%.  The Canada-US 10 year spread moved in the US market’s favour.  The US 10 year yield is trading 5 bps higher than the Canadian 10 Year yield.  The US yield curve was marginally steeper, with the difference between the 2 year and 10 year Treasury yield out 2 bps to 275.

BOTTOM LINE:  Bond yields were unchanged last week, while the yield curve moved flatter.  The fundamental backdrop looks solidly supportive.  Trader sentiment is close to oversold levels; the Commitment of Traders data is less of a drag but still not helping much, while seasonal influences are mixed for most of January.  I am positive on the bond market and recommend holding long positions with the 10 years above 3%.  The market remains stuck in a range, but we might as well earn the higher yields available in the longer issues.

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

The data and comments provided above are for information purposes only and must not be construed as an indication or guarantee of any kind of what the future performance of the concerned markets will be. While the information in this publication cannot be guaranteed, it was obtained from sources believed to be reliable.  Futures and Forex trading involves a substantial risk of loss and is not suitable for all investors.  Please carefully consider your financial condition prior to making any investments.

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