U.S. Treasury Bonds Expected to Bounce After Sharp Sell-off

By: Levente_Mady

The bond market appears to be settling down into a trading range after the sharp rally during the last 2 months of 2008. The Long Bond traded to its lowest level in nearly 2 months. My favoured scenario is that the market recovers a bit during the next 2 weeks and then it trades lower. Before that happens, traders need to deal with record size 2 and 5 Year Treasury Note auctions early in the week.

On the Central Bank front, as expected last week the Bank of Canada cut its benchmark rate from 1.5 to 1% on Tuesday. Next week the US Fed will have a policy meeting with an announcement on Wednesday. The Fed is already all in with their benchmark rate near 0% and nobody in this galaxy expecting them to raise the Fed Funds rate any time soon. We expect Central Banks to continue in easing mode for the foreseeable future.

So America got their new Prez and he is ready for action to save not only America but also the rest of the world. Watching the inauguration and soaking in some of the reaction from around the world, the contrast with the last election could not have been more striking. 4 years ago while the global economy was humming along fueled by a still expanding massive credit bubble, bumbling old G.W. got re-elected on the strength of his terror fighting credentials in spite of a highly polarized domestic voter base and a severe lack of international appeal.

This time we have Mr. Obama moving into the White House, spending $50 million on the inauguration and a few more on drapes, basket ball court and all upgrading the new digs, in the middle of the greatest financial storm in human history. He seems to be universally loved by most ethnic groups, special interest groups (all looking for handouts???) and internationally by Europeans, Africans, Asians – Christians, Muslims, Buddhist alike. He got elected on a platform of Change – terrorism and global warming are so passé these days. We are not quite sure what he is going to change, but we do know that he promised to create 3 million jobs in a hurry to replace the ones lost in 2008. He better get cracking sooner than later as the global economy is still gaining momentum to the downside. Unfortunately, like a contrary indicator, with his popularity up near the moon, he will most likely disappoint. He has a gigantic task at hand and the odds are heavily stacked against him. I hope he proves me wrong and the change he plans to implement will make a substantial difference for the next generation.

NOTEWORTHY: The economic calendar was extremely light and horrid last week. Building Permits declined 11% to 549k, while Housing Starts fell 16% to 550k – both multi-decade lows. The Federal Reserve Bank's Benchmark Rate is already at 0, but Building Permits and Housing Starts might have another 550k to go before they hit rock bottom. On the other side of the coin, Wee kly Jobless Claims jumped 62k to 589k over the past week, correcting the declines seen over the holidays and moving to a new multi-decade high.

The Canadian economic calendar is starting to show serious deterioration as well. Manufacturing Shipments declined 6.5% in November, while Retail Trade fell 2.4% during the same period to take the annual figure into the red. As is the case around the globe, Canadian Consumer Prices also declined – 0.7% in December - taking the 2008 figure down to 1.2% and still dropping, Next week's schedule will include more housing sector data, consumer confidence surveys, the Durable Goods Orders report and the first cut at the 4 th Quarter Gross Domestic Product – the pulse of the US economic activity. And if all that is not quite enough, throw in a Fed meeting on Wednesday and the above mentioned Treasury Note Auctions on Tuesday and Thursday for good measure.

INFLUENCES: Sentiment surveys further tempered their bullish bias and they are edging back to neutral territory last week. This is a slight negative as long as the momentum is down. The Commitment of Traders reports showed that Commercial traders were net long 339k 10 year Treasury Note futures equivalents – up 51k from a week ago. This is supportive for bonds. One item I would still 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. Seasonal influences will be turning positive this week. The technical picture is damaged, so I don't expect the Long Bond future to recover to the highs over 140. On the other hand, I am not forecasting a sharp sell-off either. That leaves us with a trading range: 130-140 on the bond future, 2-2.75% on the 10 year note. The market is probing the lower end of my expected price range. My bias is slightly positive for the next 2 weeks.

RATES: The US Long Bond future fell 6½ points to close at 129-19 last week, while the yield on the US 10-year note rose 30 basis points to 2.62%. The Canadian 10 year yield increased 19 basis points to 3.82%. The US yield curve was steeper as the difference between the 2 year and 10 year Treasury yield moved to 181 basis points, which is an increase of 21 bps.

BOTTOM LINE: Bond yields rose sharply, while the yield curve was steeper last week. The fundamental backdrop remains pathetic, which is supportive for bonds. Trader sentiment is slightly bullish – which is somewhat negative; Commitment of Traders positions are supportive and seasonal influences are briefly turning positive. The market is working on a top formation. After the sharp down-trade my bond market view is slightly positive at this point, anticipating a brief 2 week bounce. If the long end can't hold or bounce a tad from this level, it will be a signal of future weakness down the road.

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

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