U.S. Treasury Bond Steamroller Keeps Chugging Higher

By: Levente_Mady

The bond market just keeps on chugging higher. Yields on the 30 year Treasury Bond decreased for a 7th consecutive weeks as the Long Bond future rallied an unprecedented 29 points since the end of October. If it looks like a duck, walks like a duck and quacks like a duck, then it must be just another blow-off top. It is really no big deal, blow-offs have been a dime a dozen this year, so there is no reason to get too excited. I apologize for plagiarizing my own work from last week, but I just could not think of presenting it in a more appropriate manner. Heading into the year end, the signs of extreme distress remain evident in the bond market.

On the Central Bank activity front, the US Federal Reserve went “all in” as the Open Market Committee lowered its target rate to a more realistic 0-0.25% range in order to catch up to where the Treasury Bill market has been trading for weeks now. The Fed has gone to 0% policy rate with no effect on the economy or the financial gridlock. In an uncharacteristically bold statement, Professor Ben and his sidekicks declared that they are prepared to buy whatever is necessary – including kitchen sinks, dirty sox and abandoned camper vans – in order to beat deflation. The smart guys at the Fed and in academia call this “quantitative easing”.

Basically what it is supposed to mean is that at this point all these smart guys at the Fed, the administration, the academia and the market seem to believe at this point is that the Fed has unlimited power to print money and spend it on whatever – commercial paper, structured products, rescuing companies that are supposedly too big to fail, bonds, stocks, etc. – they choose. Maybe I am just not real smart but it appears to me that the Fed is on a fast track to self destruction. I just can't comprehend how any organization – government or otherwise – can possess unlimited spending power. Not only will the Fed continue to buy distressed assets, but officials – led by Big Ben himself – are talking about purchasing Treasury Bonds as well. Today, the banks don't want to lend to anyone but the US Treasury! The Fedsters must be forecasting that the skyrocketing Treasury supply could soon be leading to failed Treasury auctions. Otherwise why would they want to buy 10 year bonds at 2%?

NOTEWORTHY: The economic calendar did not provide much Christmas cheer last week. Manufacturing Surveys remain at distressed levels as both the NY Empire State Index and the Philadelphia Fed Index remained in deep negative territory. Capacity Utilization and Industrial Production both declined in November after a brief bounce in October. Inflation at the Consumer Price level fell more than expected, fueling worries of deflation. The housing sector just continues to surprise to the downside. Housing Starts fell 19% and Building Permits just cratered 16% in November. That is a one month change, not a year over year or year to date change.

There is just no hope on the horizon for the housing sector at this point regardless of how low mortgage rates are falling. Wee kly Jobless Claims remained elevated while dropping 21k to 554k last week. Leading Indicators declined 0.4% in November. The Canadian economy is teetering on the edge, but has not fallen off a cliff as yet. The latest Retail Sales figures are quite outdated as data for September showed a 1.1% monthly increase with the year over year rate at 5.8%. Canadian Consumer Prices fell 0.3% in November as the annual tally showed an increase of 2%. The core inflation is up 2.4% year over year. Food prices were the main culprit for higher than expected numbers in this data series. Next week's schedule in the US will be highlighted by the Final Q3 GDP release as well as Home Sales, Durable Goods Orders and Personal Spending and Income data.

INFLUENCES: Trader surveys are more excessively bullish than last week. This is a strong negative. The Commitment of Traders reports showed that Commercial traders were net long 391k 10 year Treasury Note futures equivalents – an increase of 75k from last week. This is somewhat positive for bonds. Seasonal influences are positive for most of December. The bond market is ridiculously overbought. The 10 Year Note is knocking on the 2% door, while the 30 Year Bond yield traded below 2.5%.

I asked my Mom to get me a pair of binoculars so I could spend more time bird watching instead of bond market forecasting. One item I would like to see in order to turn wildly bearish: the COT data to show commercials switching from a large long to a short position on the Long Bond contract. They have shown no interest whatsoever in heading for the exit yet. Heading into year end could be quite treacherous for both bulls and bears. We saw signs of excessive volatility last week with hardly a reason for it and year-end flows could easily exacerbate this situation.

RATES: The US Long Bond future traded up another 6 points to close at 140-25 last week, while the yield on the US 10-year note decreased another 42 basis points to 2.12%. The yield curve was stable as the difference between the 2 year and 10 year Treasury yield was 138 basis points, which represents a massive flattening of 43 basis points. As short term yields get closer to zero, the shape of the yield curve is driven by the dynamics in long term rates.

BOTTOM LINE: Bond yields declined again across the spectrum, while the yield curve was flatter last week. The fundamental backdrop remains pathetic, which is supportive for bonds. Trader sentiment is now overly bullish, Commitment of Traders positions are slightly supportive and seasonal influences are positive. The market is way overbought. My bond market view is negative at this point.

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

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