U.S. Treasury Bond Market Puts in a Top Ahead of Treasury Auctions

By: Levente_Mady

The bond market traded down again last week, oddly competing with stocks for the “most pathetic security class” title for January. The Long Bond futures declined 10.5% from the highs on December 30. In January stocks declined 8.6% but the Bond Future was off 9.2%. In spite of the mostly pathetic (and therefore supportive for the Treasury market) fundamental data, the main theme that drove trading last week was the supply both on the Treasury and corporate front. The bond friendly Fed policy statement supported the market for about 5 minutes before it buckled sharply.

The 2 year Treasury auction was relatively well received, but the demand for the 5 Year Notes auctioned on Thursday was mild at best. Month end buying did not show up or more likely it was met with plenty of selling to fill any buyer's shoes. I was expecting a 2 week window of stable to higher prices heading into the last week of January. Week one of those 2 was quite disappointing. I am looking to set up a short position by the end of the week – following the Employment report – be it on weakness or strength as we head into the Quarterly Treasury refunding during the second week of February.

On the Central Bank front, the US Fed had a policy meeting with an announcement on Wednesday. The Fed is already all in with their benchmark rate near 0% and - as expected – they indicated that the Fed Funds rate will not be raised any time soon. The Central Bank of New Zealand (RBNZ) lowered their policy rate aggressively from 4.5 to 3% because they still could. We expect Central Banks to continue in easing mode for the declined at a higher foreseeable future.

NOTEWORTHY: The economic calendar was mostly disappointing last week. We started on a semi positive note as Existing Home Sales bounced back to recoup about half of November's decline to 4.74 million units and Leading Economic Indicators eked out a 0.3% gain in December, however the annual number for 2008 shows a 3% drop for the year. Consumer Confidence remains at depressed levels. The Conference Board survey dropped to 37.7 – a new all time low (100 is neutral), while the Michigan survey remains quite weak at 61 (again 100 is neutral). Durable Goods Orders are one of the most volatile economic data series. They have also been in a free fall with the latest data point showing a 2.6% decline as the year over year tally stands at -15%. Weekly Jobless Claims stayed elevated with the latest reading almost unchanged at 588k. It is difficult to believe, but New Home Sales cratered to 331k units in December and they are off over 76% from the lofty highs of a couple years ago. The first release of the US 4 th Quarter Gross Domestic Product showed a decline of 3.8% in real (inflation adjusted) terms.

That was better that expectations of a 5.5% decline but the financial markets were not impressed as the positive surprise came on a buildup of inventories. That is not what lasting recoveries are made of. The nominal figure showed a decline of 4.1%. The Canadian economic calendar is starting to show serious deterioration as well. The November GDP declined a larger than expected 0.7% north of the border. While many experts talk about Canada lagging behind the US in the impacts of the financial turmoil, it is interesting to note that latest annual economic growth data indicates that while GDP still expanded 1.3% in America for all of 2008, Canadian GDP actually declined 0.8% during the 12 months to the end of November. Next week's schedule will start with fresh data for January. On tap we will have the Purchasing Manager Surveys for both the Manufacturing and the Services Sectors followed by the monthly Employment report on Friday on both sides of the North American border.

INFLUENCES: Sentiment surveys further tempered their bullish bias and they are 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 285k 10 year Treasury Note futures equivalents – a decline of 54k from a week ago. This is slightly 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 positive for one more week. The technical picture is damaged, so I don't expect the Long Bond future to recover a great deal. The market traded very heavy last week as positive influences from weak economic data, the supportive Fed statement or the weak stock market failed to provide much needed support. 124 was the break-out level for bonds on the way up. It is major support on the correction.

RATES: The US Long Bond future plunged another 3 points to close at 126-22 last week, while the yield on the US 10-year note rose 22 basis points to 2.84%. The Canadian 10 year yield also increased 22 basis points to 3.04%. The US yield curve was steeper as the difference between the 2 year and 10 year Treasury yield moved to 189 basis points, which is an increase of 8 bps.

BOTTOM LINE: Bond yields rose sharply, while the yield curve was steeper again last week. The fundamental backdrop remains pathetic, which is supportive for bonds. Trader sentiment is neutral; Commitment of Traders positions are supportive and seasonal influences are positive for another week. The market has put in a top. After the sharp down-trade my bond market view is slightly positive at this point, anticipating a brief bounce next week before it is faced with further pressure emanating from a slew of Treasury auctions and increasingly negative seasonality.

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

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